Vietnam: Selected Issues

International Monetary Fund

doi:10.5089/9781451840391.002.A001

Jump to Content Jump to Main Navigation

Vietnam

Selected Issues

Author: International Monetary Fund

Publication Date:: 29 Nov 2006

eISBN:: 9781451840391

Language:: English

Keywords:: ISCR; CR; Vietnam; short-term debt; price; food price inflation; inflation-inertia component; inflation in Vietnam; oil price inflation; inflation-unemployment tradeoff; Output gap; Oil prices; Price controls; Consumer price indexes; Asia and Pacific

Download PDF (617.1 KB)

Vietnam was remarkably successful in bringing down inflation in the 1990s to a single-digit range, after a period of high inflation in the late 1980s. The potential unfavorable effects of inflation on poverty and growth are well known. To shed light on these questions, this paper analyzes the available empirical evidence using several different approaches. Petroleum price increases appear to have had a modest direct effect on inflation in Vietnam, peaking at about 1 percent in 2005.

Abstract

I. What Drives Inflation in Vietnam? A Regional Approach¹

A. Introduction

1. Vietnam was remarkably successful in bringing down inflation in the 1990s to a single digit range, after a period of very high inflation in the late 1980s. Following the early years of price liberalization and economic reforms launched under the authorities’ “Doi moi”, or renovation program, inflation rose to a peak of 453 percent in 1986 and fell rapidly thereafter as macroeconomic policies were tightened. After remaining in the single digit range during the second half of the 1990s, inflation began an upward trend that accelerated in late 2003 (Figure 1). Since then, Vietnam has experienced inflationary pressures that seem more persistent than in the recent past and higher than in other emerging markets in the region, with the exception of Indonesia (Figure 2).

2. The potential unfavorable effects of inflation on poverty and growth are well-known. Inflation increases income inequality because it is essentially a regressive tax with an adverse impact on the poor (Easterly and Fischer, 2001). Because the poor do not generally hold financial assets that provide an adequate hedge against inflation, but only cash and bank deposits, inflation can quickly erode their purchasing power. Inflation can also hurt growth once it exceeds a certain threshold (Sarel, 1996; and Khan and Senhadji, 2001). High inflation clouds price signals and limits the quality and the quantity of investment. It can also hurt a country’s export competitiveness by leading to increases in domestic production costs and to an appreciation of the real exchange rate.

3. Understanding the root causes of inflation is critical in establishing the appropriate policy response. This chapter addresses several questions. Is inflation in Vietnam a worrisome phenomenon or merely a temporary change in relative prices that will be self-correcting and benign? To what extent is the recent inflation attributable to the effects of supply shocks, higher oil prices, and the liberalization of administered prices? In particular, have the above factors exerted only a transitory impact on inflation or are they likely to have had more permanent effects on core inflation? Is there any evidence that excess demand pressures have also been at play? What explains Vietnam’s inflation differential with other emerging countries in the region?

4. To shed light on these questions, the chapter analyzes the available empirical evidence using several different approaches. Section B uses a disaggregated approach to examine the key components of headline inflation, as well as some alternative measures of inflation, including proxies for core and fuel inflation. It also makes a preliminary attempt to assess the relative roles of external shocks, relative price changes (i.e., Balassa-Samuleson effects), administered prices, and demand pressures. Section C uses a more formal Vector Error Correction Model to estimate the proximate determinants of inflation in Vietnam, while Section D estimates a cross-country dynamic panel model to explain the differential behavior of inflation in Vietnam relative to other countries in the region. Section E presents a simple panel model, with country-fixed effects, to identify the threshold above which inflation is likely to exert a negative effect on growth. The main conclusions are summarized in Section F. The specification of the econometric models, as well as data issues, is reported in Annex 1.

5. The main results suggest that monetary developments have exerted an increasing influence on inflation in Vietnam over the last few years and that inflationary inertia plays a larger role in Vietnam than in other countries in the region. This suggests that reducing inflationary expectations may be more difficult than in some other countries. Furthermore, while the output gap plays a role in explaining the short-term fluctuations in the rate of inflation, movements in core inflation have become increasingly important in explaining inflation dynamics, possibly reflecting the second-round effects of oil price increases. The evidence indicating the presence of Balassa-Samuelson-type effects is mixed. The analysis on the desirable rate of inflation points to the conclusion that it is not a country’s inflation rate per se that may matter most, but how it compares with inflation in neighboring countries and trading partners.

B. Recent Determinants of Inflation in Vietnam

6. Headline inflation in Vietnam has been high by regional standards in recent years, but shows some indication of abating in 2006. However, while the year-on-year rate of inflation has declined from 9.7 percent in 2004 and 8.8 percent at the end of 2005 to 7.5 percent in August 2006, it has remained well above the rates prevailing in Vietnam’s major trading partners.

7. Cross-country data suggest that the volatility and persistence in Vietnam’s inflation have also been high compared to other emerging economies in Asia (Table 1 and Section D below). While a number of external shocks, including rising food and oil prices, were the dominant causes of inflation beginning in 2004, most of these shocks were common to the rest of the region. Although food price inflation began to decelerate in 2005, headline inflation remained on an upward trend, at least until the beginning of 2006. The series of nonfood prices excluding oil components, which was constructed as a proxy for core inflation, shows that core inflation trended up in Vietnam at a faster rate than in most neighboring countries (Figure 3).

Table 1.

Vietnam and Emerging Asia: Headline Inflation Statistics, 2002Q1–2006Q2 ^1/^2/

(In percent)

Sources: General Statistics Office; and Fund staff estimates.

^{^1/}Monthly data.

^{^2/}ASEAN-4 includes: Indonesia, Malaysia, Philippines, and Thailand. NIEs includes: Hong Kong, Korea, Singapore, and Taiwan POC. Selected Emerging Asian Countries include: China, Indonesia, Korea, Malaysia, Philippines, Singapore, Thailand, and Vietnam.

Table 1.

Vietnam and Emerging Asia: Headline Inflation Statistics, 2002Q1–2006Q2 ^1/^2/

(In percent)

	Mean	Median	Maximum	Minimum	Std. Dev.
ASEAN-4	5.8	5.1	10.8	3.1	2.2
Newly-industrialized economies (NIEs)	1.8	1.8	3.5	0.3	0.7
Selected Emerging Asian Countries	2.6	2.7	5.0	0.8	1.1
Vietnam	6.0	5.6	10.4	1.6	2.6

Sources: General Statistics Office; and Fund staff estimates.

^{^1/}Monthly data.

Table 1.

Vietnam and Emerging Asia: Headline Inflation Statistics, 2002Q1–2006Q2 ^1/^2/

(In percent)

	Mean	Median	Maximum	Minimum	Std. Dev.
ASEAN-4	5.8	5.1	10.8	3.1	2.2
Newly-industrialized economies (NIEs)	1.8	1.8	3.5	0.3	0.7
Selected Emerging Asian Countries	2.6	2.7	5.0	0.8	1.1
Vietnam	6.0	5.6	10.4	1.6	2.6

Sources: General Statistics Office; and Fund staff estimates.

^{^1/}Monthly data.

8. The above observations suggest that some factors that may be specific to Vietnam may have magnified and perpetuated the impact of external shocks on inflation. The remainder of this section makes a preliminary attempt to ascertain the presence of such idiosyncratic factors. Following a review of the nature of the recent external shocks, and their apparent effects on inflation in Vietnam since 2004, the section assesses in turn the possible roles of productivity-driven changes in relative prices, changes in policies relating to administered prices, and demand pressures.

The food supply and oil price shocks

9. Food price inflation in Vietnam has been both higher and more volatile² than in the other countries in the region, and it was by far the most important contributor to the pick-up of inflation beginning in 2004 (Table 2). This appears to have reflected a combination of factors on both the supply and demand sides. The pick-up of international food prices, especially rice, of which Vietnam is the world’s second largest exporter, was undoubtedly a major factor in early 2004 (Figures 4 and 5). Although the government tried to moderate the impact on domestic prices by regulating the quantity of rice exports, an outbreak of avian flu, which also occurred in early 2004, led to increasing pressures on beef, fish and seafood prices, while widespread droughts subsequently led to supply shortfalls for other domestically-produced food products. As the impact of the initial supply shocks abated, inflation in the prices of food staples, which include mainly rice and cereal products, moderated somewhat in 2005. However, inflation in the prices of foodstuffs, which include a much broader variety of items, remained in the double-digit range in 2005, suggesting that demand pressures may have also been at play. In particular, the progressive increase in the common minimum wage, together with large adjustments in the civil service wage scale introduced under the government’s Public Administration Reform Program, led to considerable increase in the purchasing power of wages. ³ This, combined with the rising level of economic activity and a generalized increase in aggregate demand, is likely to have fueled expectations of rising inflation, thus exacerbating and prolonging the inflationary impact of supply-side shocks in the agricultural sector.⁴ Indeed, demand pressures may well have had a more immediate impact on food rather than nonfood components of the CPI during the recent period for at least two reasons. First, food markets in Vietnam are much more decentralized and less prone to be subjected to formal or informal price controls, which may have been applied to varying degrees in other sectors, as discussed below. Second, even in fully-liberalized market economies, empirical studies have found that prices are least sticky in wholesale and retail trade (which typically include most food distribution) and most sticky in the service sector (which account for a large share of Vietnam’s nonfood CPI).⁵

Table 2.

Vietnam: CPI Inflation, 2003-06

Sources: General Statistics Office; and Fund staff estimates.

Table 2.

Vietnam: CPI Inflation, 2003-06

			2003	2004	2005	Jan 2006- Aug 2006
			(Period average, Annual percentage change)
CPI Inflation			3.2	7.7	8.3	7.8
of which:
	Food and foodstuff		2.5	12.6	11.3	9.0
	of which: Staples		0.6	12.7	9.0	7.8
		Other food	3.4	13.4	12.2	9.3
	Non-food:		3.9	3.0	5.0	6.6
	of which: Garments		2.4	4.3	4.2	5.9
		Housing and construction	8.2	6.6	7.2	9.8
		Household goods and equipment	1.2	3.1	4.3	5.2
		Transportation	1.6	1.6	8.3	8.8
		Others	4.1	4.6	3.7	4.8
			(Period average, Contribution to CPI inflation)
	Food and foodstuff		1.1	5.4	4.9	3.8
	of which: Staples		0.1	1.3	0.9	0.8
		Other food	1.0	4.1	4.0	3.1
	Non-food:		2.1	2.3	3.4	4.0
	of which: Garments		0.2	0.3	0.3	0.5
		Housing and construction	0.7	0.5	0.6	0.8
		Household goods and equipment	0.1	0.3	0.4	0.5
		Transportation	0.2	0.2	0.8	0.9
		Others	0.9	1.0	1.3	1.3

Sources: General Statistics Office; and Fund staff estimates.

Table 2.

Vietnam: CPI Inflation, 2003-06

			2003	2004	2005	Jan 2006- Aug 2006
			(Period average, Annual percentage change)
CPI Inflation			3.2	7.7	8.3	7.8
of which:
	Food and foodstuff		2.5	12.6	11.3	9.0
	of which: Staples		0.6	12.7	9.0	7.8
		Other food	3.4	13.4	12.2	9.3
	Non-food:		3.9	3.0	5.0	6.6
	of which: Garments		2.4	4.3	4.2	5.9
		Housing and construction	8.2	6.6	7.2	9.8
		Household goods and equipment	1.2	3.1	4.3	5.2
		Transportation	1.6	1.6	8.3	8.8
		Others	4.1	4.6	3.7	4.8
			(Period average, Contribution to CPI inflation)
	Food and foodstuff		1.1	5.4	4.9	3.8
	of which: Staples		0.1	1.3	0.9	0.8
		Other food	1.0	4.1	4.0	3.1
	Non-food:		2.1	2.3	3.4	4.0
	of which: Garments		0.2	0.3	0.3	0.5
		Housing and construction	0.7	0.5	0.6	0.8
		Household goods and equipment	0.1	0.3	0.4	0.5
		Transportation	0.2	0.2	0.8	0.9
		Others	0.9	1.0	1.3	1.3

Sources: General Statistics Office; and Fund staff estimates.

10. Petroleum price increases appear to have had a modest direct effect on inflation in Vietnam, peaking at about 1 percent in 2005 (Table 3).⁶ This low contribution has been a result of the relatively small direct weight of petroleum products in the CPI basket, together with the government’s use of a combination of import duty reductions and the management of administered prices to contain the indirect effects on inflation in the short run. While domestic oil prices were increased nine times between end-2003 and August 2006, they generally remained below the levels of world prices. Nevertheless, Vietnam made further progress in passing through world petroleum prices during 2006. Average petroleum prices were raised in two stages in April and August 2006, by a cumulative 18.5 percent. Following these increases, the pass-through of increases in international oil prices since 2003 was deemed to have been complete for gasoline and kerosene, but still incomplete for diesel. With international oil prices beginning to retreat in September, the authorities reinstated the import duty on most petroleum products other than kerosene and diesel, initially at a level of 5 percent and subsequently increased to 15 percent, and reduced gasoline prices by 8.5 percent.

Table 3.

Vietnam: Petroleum Prices: Direct and Indirect Contributions to Headline Inflation, 2001-05

(In percent)

Sources: General Statistics Office; and Fund staff estimates.

^{^1/}Accounting for 3.27 percent of the CPI basket until April 2006.

^{^2/}Accounting for 2.6 percent of the CPI basket until April 2006.

Table 3.

Vietnam: Petroleum Prices: Direct and Indirect Contributions to Headline Inflation, 2001-05

(In percent)

				2001	2002	2003	2004	2005
Petroleum Prices				0.02	0.14	0.22	0.83	1.02
	Direct effect ^1/
		of which: Fuel for cooking		0.03	0.11	0.08	0.27	0.44
			Fuel and lubricants	-0.02	0.01	0.10	0.52	0.49
	Indirect effect ^2/
		of which: Public transport		0.01	0.03	0.04	0.04	0.09
			Electricity	0.03	0.31	0.02	0.00	0.01

Sources: General Statistics Office; and Fund staff estimates.

^{^1/}Accounting for 3.27 percent of the CPI basket until April 2006.

^{^2/}Accounting for 2.6 percent of the CPI basket until April 2006.

Table 3.

Vietnam: Petroleum Prices: Direct and Indirect Contributions to Headline Inflation, 2001-05

(In percent)

				2001	2002	2003	2004	2005
Petroleum Prices				0.02	0.14	0.22	0.83	1.02
	Direct effect ^1/
		of which: Fuel for cooking		0.03	0.11	0.08	0.27	0.44
			Fuel and lubricants	-0.02	0.01	0.10	0.52	0.49
	Indirect effect ^2/
		of which: Public transport		0.01	0.03	0.04	0.04	0.09
			Electricity	0.03	0.31	0.02	0.00	0.01

Sources: General Statistics Office; and Fund staff estimates.

^{^1/}Accounting for 3.27 percent of the CPI basket until April 2006.

^{^2/}Accounting for 2.6 percent of the CPI basket until April 2006.

11. However, the second-round effects of the oil price shock are likely to have been substantial. As already noted, core inflation has trended up in recent years. This trend reflects significant contributions from increases in the prices of housing and construction materials, transportation and telecommunications, garments, and household goods and equipment, which are likely to include some second-round effects of the surge in oil prices, and can be viewed as a measure of the persistent effects of the recent supply shocks.⁷ As illustrated in Figure 6, core and oil price inflation have increased in tandem in recent years (the correlation coefficient between the two series amounted to 0.86 over the period January 2003–April 2006).⁸

Is inflation in Vietnam explained by the Balassa-Samuleson effect? The role of relative prices

12. Another question on the recent trend in inflation is the extent to which it has reflected changes in the prices of tradable relative to nontradable goods (Table 4). While in 2004 headline inflation was dominated by increases in prices of internationally traded goods, particularly food and energy, and the increases in the prices of nontradables remained more restrained, increases in the prices of nontradables gathered pace recently.

There was a significant appreciation of the real effective exchange rate in 2005, reflecting also the recent de facto peg of the dong to the U.S. dollar, and the consequent nominal effective appreciation of the dong during 2005. While these trends were attenuated in 2006, as the earlier appreciation of the nominal effective exchange was reversed, a key question is whether the increases in the prices of nontradables should be expected to become a major driver of inflation in the period ahead.

Table 4.

Vietnam: Price Indicators, 2003-06

Sources: General Statistics Office; WEO database; and Fund staff estimates.

Table 4.

Vietnam: Price Indicators, 2003-06

		2003	2004	2005	Jan 2006– Aug 2006 Prel.
		(Period average, Annual percentage change)
CPI inflation		3.2	7.7	8.3	7.8
	Price of nontradables	4.1	6.6	5.9	7.5
	Price of tradables	2.8	8.1	9.0	8.1
Relative price of nontradables/tradables		1.2	-1.4	-2.8	-0.6
GDP deflator		6.7	8.2	8.0	…
Import prices		3.2	5.4	-0.9	…
Export prices		1.1	6.6	11.8	…

Sources: General Statistics Office; WEO database; and Fund staff estimates.

Table 4.

Vietnam: Price Indicators, 2003-06

		2003	2004	2005	Jan 2006– Aug 2006 Prel.
		(Period average, Annual percentage change)
CPI inflation		3.2	7.7	8.3	7.8
	Price of nontradables	4.1	6.6	5.9	7.5
	Price of tradables	2.8	8.1	9.0	8.1
Relative price of nontradables/tradables		1.2	-1.4	-2.8	-0.6
GDP deflator		6.7	8.2	8.0	…
Import prices		3.2	5.4	-0.9	…
Export prices		1.1	6.6	11.8	…

Sources: General Statistics Office; WEO database; and Fund staff estimates.

13. More specifically, it would be important to ascertain the extent to which the recent upward trend in inflation in Vietnam is a result of an adjustment of the relative prices of nontradable goods and services, as suggested by the Balassa-Samuelson hypothesis. The Balassa-Samuelson effect arises when a developing economy experiences large productivity gains in the tradable sectors that trigger generalized wage increases and higher inflation in the nontradable sector, resulting in cost-push inflation in the nontradable goods sector. If the underlying dynamics of prices are due to this process, inflation can be viewed as a temporary side-effect of an equilibrium movement in relative prices that would eventually subside as the productivity gap between the tradable goods sectors in Vietnam and its trading partners diminishes. In such a case, an increase in inflation driven by the productivity gap between the two sectors would be only transitory and self-limiting and should not be a cause of concern.

14. The evidence indicating the presence of the Balassa-Samuelson hypothesis in Vietnam is mixed. On one hand, Figure 7 points to a trend increase in productivity in the tradable sector relative to the nontradable sector, which is in line with the prediction of the Balassa-Samuelson hypothesis. Moreover, Figure 8 shows that labor productivity has increased more rapidly in Vietnam than in the more advanced partner countries, as proxied by the United States, and that the real exchange rate has appreciated. These developments are consistent with the Balassa-Samuelson hypothesis.

15. On the other hand, there is no evidence of a medium-term trend increase in the relative price of nontraded goods compared to traded goods. According to the Balassa-Samuelson effect, the latter should show a strong upward trend. Thus, it is difficult to attribute the recent years’ inflation to equilibrating changes in relative prices between the tradable and nontradable sectors.⁹

16. A possible way to reconcile this apparently conflicting picture is by arguing that in a dual economy, where a big part of the labor force is still underemployed in the agricultural sector, it is not surprising to find only slight evidence of the pass-through of the impact of tradable sector productivity gains on wages in other sectors. This is because any upward pressure on wages in the lower-productivity nontradables sector is likely to be limited as long as a large pool of underemployed labor in agriculture remains willing and able to secure employment in the nonagricultural sector at currently prevailing wages (see, e.g., Harris-Todaro, 1970).

The role of administered prices

17. Changes in policies relating to administered prices could also play an important role in influencing inflation dynamics. Administered prices are currently officially estimated to account for less than 10 percent of Vietnam’s CPI basket, but they were much more prevalent at earlier stages of the transition to a market-based system. In general, price liberalization, in and of itself, should not cause permanent increases in the rate of inflation, but should only lead to one-off adjustments in the price level during the period in which it occurs. In Vietnam, a large number of prices were controlled between 1992 and 2002, in accordance with Decision 137 of April 27, 1992. The prices of several important commodities, including rice, cement, urea fertilizer, and steel for construction, were liberalized to a great extent during 2002–04.¹⁰ However, key prices and tariffs, including for electricity, water, petroleum products, air tickets, bus fares, postal services and telecom charges continue to be set by the government, and some of the prices for other key inputs remain subject to legal ceilings or administratively set price ranges. The government has tightened controls over these prices over the last two years as a part of its efforts to limit inflation.

18. Indeed, the largest increases in inflation occurred after the bulk of price liberalization took place, and during a period in which the administrative controls on some prices were tightened. As a result, it is entirely possible that the actual rate of inflation may have understated the extent of inflationary pressures over the last two years. Against this background, while it is difficult to argue that price liberalization has made a significant contribution to the recent up-tick in inflation, it probably played a role in increasing the impact of monetary conditions on inflation, as discussed below.

The role of demand pressures

19. Excess demand pressure or overheating of the economy is a common cause of inflation in both industrial and developing countries. A frequently-used measure of the extent of such pressure is the output gap. The most common definition of the output gap is the difference between actual output and potential output, with the latter defined as the level of output consistent with stable inflation. When output grows above its long-term potential rate, inflation would start to increase as bottlenecks in production, capacity limits and a tightening of labor markets would lead workers to demand higher wages and firms to increase their prices and wages as their costs of production and demand for their products rise. The output gap has been successfully applied in many studies to test the traditional Phillips curve specification of the inflation-unemployment tradeoff. While there is considerable evidence that the output gap is an important factor in determining inflation in advanced economies, its applicability to emerging economies should be taken with caution, as the conditions of near-full employment are rarely in place.

20. A preliminary effort to assess the extent that the output gap has been an important determinant of inflation in Vietnam over the period Q1 2000–Q2 2006 does not point to any consistent pattern of causality, partly because the output gap exhibited limited variability through most of this period. However, the more recent data suggest that the increase in inflation during 2005 could be partly attributed to the fact that the output gap is estimated to have been above potential during 2005 (Figure 9). Short-term fluctuations of inflation appear to be particularly influenced by the behavior of the output gap. This can be seen in Figure 10 that plots the first differences of CPI inflation and the output gap. The econometric analysis provided in section D below corroborates some of these findings.

21. The growth of monetary and/or credit aggregates is another commonly used indicator of the extent of demand pressures, which may also be a useful gauge of the thrust of monetary policy. Previous empirical studies have found little evidence of a robust link between monetary growth and inflation in Vietnam, despite a sustained rapid growth of monetary and credit aggregates.¹¹ This could be attributed in part to the rapid structural transformation of the economy since the launching of the authorities’ renovation program in the late 1980s, which may have resulted in sustained rapid increases in private saving and money demand. However, there is some evidence that the correlation between money and inflation has become positive and strong beginning in 2002, with trends in monetary aggregates appearing to affect inflation with a lag of about 12 months (see correlation matrix, Tables 5 and 6, and Figure 11). The growth of credit to the economy appears to be even more highly correlated with CPI inflation during this recent period, suggesting that credit may have become a useful leading indicator of inflation. Of course these findings need to be viewed with caution, as the fact that inflation appears to be correlated with lagged monetary and credit aggregates is not a proof of causation (Tobin, 1971), especially during a period in which the money demand function may have shifted significantly.

Table 5.

Vietnam: Correlation Matrix: CPI and Selected Variables, 2000Q1-2006Q2

Source: Fund staff estimates.

Table 5.

Vietnam: Correlation Matrix: CPI and Selected Variables, 2000Q1-2006Q2

									Reserve	Reserve
	CPI inf.	Output gap	Credit	Credit t-1	Credit t-2	M2	M2 t-1	M2 t-2	money	money t-1	NEER t-2
CPI inflation	1.00
Output gap	0.21	1.00
Credit	0.06	0.29	1.00
Credit t-1	0.07	0.39	0.86	1.00
Credit t-2	0.17	0.47	0.52	0.82	1.00
M2	-0.38	0.16	0.54	0.59	0.49	1.00
M2 t-1	-0.53	0.08	0.47	0.57	0.46	0.92	1.00
M2 t-2	-0.62	0.12	0.38	0.52	0.49	0.80	0.93	1.00
Reserve money	-0.44	0.01	-0.16	-0.11	-0.02	0.34	0.25	0.21	1.00
Reserve money t-1	-0.70	-0.20	-0.09	-0.07	-0.15	0.45	0.50	0.39	0.59	1.00
NEER t-2	-0.48	0.04	-0.28	-0.03	0.26	0.39	0.55	0.63	0.26	0.33	1.00

Source: Fund staff estimates.

Table 5.

Vietnam: Correlation Matrix: CPI and Selected Variables, 2000Q1-2006Q2

									Reserve	Reserve
	CPI inf.	Output gap	Credit	Credit t-1	Credit t-2	M2	M2 t-1	M2 t-2	money	money t-1	NEER t-2
CPI inflation	1.00
Output gap	0.21	1.00
Credit	0.06	0.29	1.00
Credit t-1	0.07	0.39	0.86	1.00
Credit t-2	0.17	0.47	0.52	0.82	1.00
M2	-0.38	0.16	0.54	0.59	0.49	1.00
M2 t-1	-0.53	0.08	0.47	0.57	0.46	0.92	1.00
M2 t-2	-0.62	0.12	0.38	0.52	0.49	0.80	0.93	1.00
Reserve money	-0.44	0.01	-0.16	-0.11	-0.02	0.34	0.25	0.21	1.00
Reserve money t-1	-0.70	-0.20	-0.09	-0.07	-0.15	0.45	0.50	0.39	0.59	1.00
NEER t-2	-0.48	0.04	-0.28	-0.03	0.26	0.39	0.55	0.63	0.26	0.33	1.00

Source: Fund staff estimates.

Table 6.

Vietnam: Correlation Matrix: CPI and Selected Variables, 2002Q1-2006Q2

Source: Fund staff estimates.

Table 6.

Vietnam: Correlation Matrix: CPI and Selected Variables, 2002Q1-2006Q2

									Reserve	Reserve
	CPI inf.	Output gap	Credit	Credit t-1	Credit t-2	M2	M2 t-1	M2 t-2	money	money t-1	NEER t-2
CPI inflation	1.00
Output gap	0.36	1.00
Credit	0.66	0.29	1.00
Credit t-1	0.79	0.40	0.91	1.00
Credit t-2	0.79	0.48	0.67	0.88	1.00
M2	0.72	0.27	0.39	0.58	0.75	1.00
M2 t-1	0.69	0.21	0.33	0.53	0.74	0.86	1.00
M2 t-2	0.48	0.24	0.14	0.34	0.65	0.51	0.74	1.00
Reserve money	-0.31	0.02	-0.39	-0.28	-0.13	0.06	-0.10	-0.21	1.00
Reserve money t-1	-0.55	-0.19	-0.42	-0.33	-0.25	0.01	-0.03	-0.23	0.59	1.00
NEER t-2	0.03	0.12	-0.51	-0.33	0.03	0.17	0.37	0.50	0.12	0.09	1.00

Source: Fund staff estimates.

Table 6.

Vietnam: Correlation Matrix: CPI and Selected Variables, 2002Q1-2006Q2

									Reserve	Reserve
	CPI inf.	Output gap	Credit	Credit t-1	Credit t-2	M2	M2 t-1	M2 t-2	money	money t-1	NEER t-2
CPI inflation	1.00
Output gap	0.36	1.00
Credit	0.66	0.29	1.00
Credit t-1	0.79	0.40	0.91	1.00
Credit t-2	0.79	0.48	0.67	0.88	1.00
M2	0.72	0.27	0.39	0.58	0.75	1.00
M2 t-1	0.69	0.21	0.33	0.53	0.74	0.86	1.00
M2 t-2	0.48	0.24	0.14	0.34	0.65	0.51	0.74	1.00
Reserve money	-0.31	0.02	-0.39	-0.28	-0.13	0.06	-0.10	-0.21	1.00
Reserve money t-1	-0.55	-0.19	-0.42	-0.33	-0.25	0.01	-0.03	-0.23	0.59	1.00
NEER t-2	0.03	0.12	-0.51	-0.33	0.03	0.17	0.37	0.50	0.12	0.09	1.00

Source: Fund staff estimates.

22. A number of factors aside from the process of monetization of the economy may account for the complexity of the interrelationships between monetary and credit aggregates and inflation in Vietnam over the last decade. First, as already noted, the authorities have pursued a policy of a de facto peg of the dong to the U.S. dollar through most of the period under review, with the notable exception of the period of the Asian crisis in the late 1990s, when the dong/U.S. dollar rate depreciated significantly. As a result, the exchange rate has been an important anchor of stability, and helped contain increases in import prices at a time that the opening up of the trade system allowed consumers to channel an increasing share of their demand into imports. Indeed, the nominal effective appreciation of the dong during 2000–01 is likely to have played an important role in reducing inflation during that period.

23. Second, and partly as a consequence of this exchange rate policy, monetary growth was to a large extent fueled by market-driven increases in net foreign assets rather than by policy factors (e.g., recourse to heavy bank financing of fiscal deficits). At the same time, the largely state-owned banking system accumulated a substantial amount of excess liquidity, which served to moderate the impact of the money-credit multiplier that might otherwise amplify the growth in money and credit. It is possible that the above effects wore off in recent years, as import penetration into the domestic market leveled off and state-owned banks intensified their lending to help meet the government’s ambitious investment and growth targets. Moreover, as noted above, the liberalization of administered prices is likely to have increased the responsiveness of domestic prices to monetary actions and other factors that affect aggregate demand.

C. An Error Correction Model

24. This section uses a more systematic estimation technique, based on a Vector Error Correction Model (VECM), to investigate the extent to which movements in monetary aggregates, the output gap, and the nominal exchange rate have affected inflation in Vietnam. This method allows us to simultaneously estimate the relationships among all variables of interest. The approach is similar to Khan and Schimmelpfenning (2006). The model is estimated for the period 2001Q1–2006Q2 on a quarterly basis, and includes the following variables: the headline CPI, broad money (M2), the nominal effective exchange rate (NEER), and the output gap.¹² The specification of the estimated system is provided in Annex 1. The accumulated impulse responses to shocks standardized to one standard deviation are presented over a two-year horizon.

25. The results (Figure 12) indicate that:

Monetary factors have been important in influencing inflation in Vietnam and they are estimated to have affected CPI dynamics with a lag of about 12 months.
CPI responds positively to a narrowing output gap (i.e., as actual GDP increases relative to potential, inflationary pressures begin to emerge).
A depreciation of the nominal exchange rate does lead to pressure on the CPI, but the degree of pass-through is relatively modest and incomplete.¹³ This rather modest effect may be related to the very limited movement of the exchange rate in the sample period, together with the presence of administered prices, which may have distorted measures of the pass-through of exchange rate changes.
A positive shock to broad money temporarily increases output with a one-year lag, but it does not have a positive long-term effect on output. The positive impact on output disappears after two years—a result that is in line with other empirical studies (see, for example, Christiano, Eichenbaum, and Evans, 1996).
A nominal depreciation of the exchange rate has a temporary positive effect on output, which peaks after about one year, but subsequently tapers off and eventually disappears. Presumably, this is the result of price effects induced by the nominal depreciation, which over time cause the real exchange rate to change by less than the nominal rate.

D. What Explains Vietnam’s Relatively High Inflation Rate Compared to Other Countries in the Region? A Dynamic Panel Model

26. Since 2004, headline inflation in Vietnam has been higher than in other emerging Asian countries, with the sole exception of Indonesia (Figure 13). Some stylized facts common to all countries in the sample indicate that inflation is largely a monetary phenomenon, especially for the period beginning in 2003 (Figure 14), and is closely correlated with credit growth.¹⁴ It is also negatively correlated with openness—defined as imports over GDP—and with the NEER.¹⁵

27. A cross-country dynamic panel model has been estimated to cast light on how the sources of inflation in Vietnam may have differed from those of the other countries in the region. The panel includes China, Indonesia, Korea, Malaysia, Philippines, Singapore, and Thailand, as well as Vietnam. The sample consists of quarterly data covering Q12000 – Q2 2006, which is the longest common period over which an internally consistent data set is available.¹⁶ The model was estimated using a differenced generalized method-of-moments (GMM) estimator that allows past actual values of the dependent variable (in this case CPI inflation) to affect its current level without being subject to the problems of endogeneity present in dynamic panel analysis.

28. The econometric model was estimated using the following variables: current inflation (dependent variable), lagged inflation, which captures the inflation-inertia component, lagged broad money to capture lags in the transmission of monetary policy; lagged NEER, which is intended to captures the degree of pass-through from the exchange rate to domestic prices; and lagged output gap, as a measure of excess demand pressures. The output gap is estimated using the Hodrick-Prescott Filter (HP filter) and is measured as the deviation, in percentage points, of actual seasonally adjusted output from a measure of GDP trend. A positive number indicates that output is above trend. Finally, country-specific dummies for Vietnam are introduced in the different regressions to explain how much more or less each of the sources of inflation counts in Vietnam compared to the other countries in the region. Annex 1 provides more details on the specification of the estimated model.

Econometric results

29. The econometric results suggest that, for all the countries in the sample, past inflation, the output gap, broad money, and NEER are important determinants of inflation (Table 7). As expected, current inflation depends positively on past inflation, the output gap, and broad money, and negatively on the NEER. The degree of openness played no role in explaining inflation across the sample (this result is not shown).

Table 7.

Sources of Inflation in Vietnam and Selected Asian Countries ^1/

Source: Fund staff estimates.

^{^1/}Dependent variable CPI inflation. Differenced GMM estimates, based on quarterly data, 2000Q1–2006Q2.

^{^2/}Regression (3) covers the period 2002Q1–2006Q2. *, ** and *** denote significantly different from zero at 10, 5, and 1 percent level, respectively. The sample includes: China, Indonesia, Korea, Malaysia, Philippines, Singapore, Thailand, and Vietnam.

Table 7.

Sources of Inflation in Vietnam and Selected Asian Countries ^1/

			Regressions
	(1)	(2)	(3) ^2/	(4)	(5)
Past inflation (cpi _t-1)	0.61***	0.64***	0.62***	0.66***	0.67***
M2 growth (t-1)	0.044**	0.079***	0.016**	0.039**	0.022
NEER growth (t-2)	-0.034***	-0.025**	-0.422***	-0.027**	-0.036***
Output gap (t-1)	0.094**	0.089**	0.045	0.086**	0.080*
Past inflation (VNM dummy)	0.18***	…	…	…	…
M2 growth (VNM dummy)	…	-1.268**	0.080*	…	…
NEER growth (VNM dummy)	…	…	…	-0.094**	…
Output gap (VNM dummy)	…	…	…	…	0.05
Observations	184	184	152	184	184
			P-value
Sargan test	0.991	0.992	0.992	0.993	0.996
Test of Autocorrelation of order 1	0.000	0.000	0.010	0.000	0.000
Test of Autocorrelation of order 2	0.102	0.114	0.205	0.103	0.104

Source: Fund staff estimates.

^{^1/}Dependent variable CPI inflation. Differenced GMM estimates, based on quarterly data, 2000Q1–2006Q2.

Table 7.

Sources of Inflation in Vietnam and Selected Asian Countries ^1/

			Regressions
	(1)	(2)	(3) ^2/	(4)	(5)
Past inflation (cpi _t-1)	0.61***	0.64***	0.62***	0.66***	0.67***
M2 growth (t-1)	0.044**	0.079***	0.016**	0.039**	0.022
NEER growth (t-2)	-0.034***	-0.025**	-0.422***	-0.027**	-0.036***
Output gap (t-1)	0.094**	0.089**	0.045	0.086**	0.080*
Past inflation (VNM dummy)	0.18***	…	…	…	…
M2 growth (VNM dummy)	…	-1.268**	0.080*	…	…
NEER growth (VNM dummy)	…	…	…	-0.094**	…
Output gap (VNM dummy)	…	…	…	…	0.05
Observations	184	184	152	184	184
			P-value
Sargan test	0.991	0.992	0.992	0.993	0.996
Test of Autocorrelation of order 1	0.000	0.000	0.010	0.000	0.000
Test of Autocorrelation of order 2	0.102	0.114	0.205	0.103	0.104

Source: Fund staff estimates.

^{^1/}Dependent variable CPI inflation. Differenced GMM estimates, based on quarterly data, 2000Q1–2006Q2.

30. The econometric results on Vietnam show a higher degree of persistence in inflation than in the other countries (Table 7, regression 1). In particular, one percentage point of past inflation is associated with an inflation increase of about 0.79 percent in the current period in Vietnam—0.18 percentage points higher than the sample average. As shown in Figure 15, the effects of a shock on inflation last almost twice as long in Vietnam as in the other Asian countries. For example, a one percentage increase in inflation would typically take 10 quarters to disappear in the selected Asian countries and about 20 quarters in Vietnam. The higher inertia component may reflect the sluggish adjustment of inflationary expectations, also related to the public’s memory of high inflation that lasted until 1993. This also suggests that once inflationary expectations are entrenched, it is more difficult to control inflation.

31. The econometric results also suggest that money had a negative effect on inflation in Vietnam, unlike in the other countries in the region during the sample period 2000Q1–2006Q2 (Table 7, regression 2), but this effect becomes positive, statistically significant and stronger than in the other countries over the period 2002–06 (regression 3). This result is consistent with the foregoing discussion in Section B and could be partly explained by the liberalization of administered prices that may have strengthened the transmission mechanism through which aggregate demand affects inflation from 2002 onwards. Based on the results for the period 2002Q1–2006Q2, a one percentage point increase in broad money is associated with an increase in inflation of about 0.1 percent (0.016+0.08), equivalent to 0.08 percentage points higher than in other countries.

32. A depreciation of the NEER by one percentage point is associated with an increase in inflation of 0.12 percent in Vietnam, approximately 0.1 percentage points higher than in the rest of the sample (Table 7, regression 4). The excess demand pressures, proxied by the output gap, have similar effects in Vietnam and other countries in the region (i.e., the coefficient on the dummy on Vietnam representing the output gap in regression 5 is not significant). This suggests that a one percentage point increase in the output gap will increase inflation by the same amount as in the other emerging countries in the sample.¹⁷

E. Inflation and Growth

33. High inflation negatively affects both the poor and economic growth. A cursory look at Vietnam’s growth performance since the launching of its reforms in the 1980s indicates that growth has been lowest during periods of high inflation. Figure 16 shows that real per capita GDP growth is clearly positively correlated in Vietnam with a declining trend in inflation. In particular, real GDP per capita was severely depressed as inflation surged during the early years of transition, but recovered strongly as inflation was brought back under control in the 1990s.

34. Several empirical studies provide evidence that inflation may have a negative impact on growth once it exceeds a certain threshold and that the relationship between inflation and growth is non linear, as first identified by Fischer (1993). At low levels of inflation, the relationship can be non-existent, or even positive, while at higher rates it becomes negative. Several authors (Sarel 1996, Gosh and Phillips, 1998, Khan and Senhadji, 2000 among others) have tried to identify such a kink in the relationship between inflation and growth. Empirical studies pointed to a wide range of values for the threshold after which inflation has negative impact on growth somewhere in between 3 percent (Burdekinm et al., 2000) and 40 percent (Bruno and Easterly, 1998). Extending this analysis, more recent empirical studies have aimed to identify the so-called optimal inflation rate. Khan (2005) for example finds that the optimal rate for Middle Eastern and Central Asian countries is on the order of 3.2 percent.

35. In the case of the Asian countries, including Vietnam, we find a similarly low optimal rate of inflation. Figure 17 shows that a negative relationship exists between inflation and growth for a selected sample of Asian countries over the period 1980–2005.¹⁸ This graphic result is confirmed by model (1) in Table 8, where real GDP of the sample countries is regressed on the log of inflation. Country-fixed effects are included in the model to control for country-specific factors. However, regression 1 assumes that the relationship is linear. We allow for non-linearity by assuming a quadratic relationship between inflation and growth in line with Khan (2005). The econometric results of this exercise are reported in Table 8, model 2. The coefficient on log inflation is positive, but the coefficient on square of log inflation is negative. This suggests that, at a very low level of inflation, the relationship between growth and inflation is positive, but after a certain point the relationship becomes negative. The concavity of the relationship between growth and inflation implies that an optimal growth-maximizing level of inflation exists, which is estimated to be 3.6 percent (Figure 18) in this model in line with the rate estimated by Khan (2005).

Table 8.

Relationship Between Inflation and Growth in Selected Asian Countries ^1/

Source: Fund staff estimates.

^{^1/}Dependent variable is real GDP growth. The sample period is 1980–2005. *, ** and *** denote significantly different from zero at 10 percent, 5 percent, and 1 percent level, respectively. The sample includes: Indonesia, Korea, Malaysia, Philippines, Singapore, Thailand, and Vietnam.

Table 8.

Relationship Between Inflation and Growth in Selected Asian Countries ^1/


	(1)	(2)
Log inflation	-0.47	0.3102
Square of log inflation	…	-0.3198***
Observations	173	173

Source: Fund staff estimates.

Table 8.

Relationship Between Inflation and Growth in Selected Asian Countries ^1/


	(1)	(2)
Log inflation	-0.47	0.3102
Square of log inflation	…	-0.3198***
Observations	173	173

Source: Fund staff estimates.

36. The lower threshold estimated in this study seems plausible in light of the fact that global inflation has been much more contained in recent years than it was in previous decades. While the above estimates are at the low end of the range reported in the empirical literature, most of that literature covered an earlier period when global inflation was higher. In this context, it is entirely possible that optimal inflation rate for any given country depends critically on the inflation rate of major trading partners and regional competitors.

F. Conclusions

37. This chapter has employed several empirical approaches to shed light on the nature of the inflation process in Vietnam. A number of important structural changes that have taken place in the economy over the last two decades make it difficult to estimate stable behavioral relationships for key macroeconomic variables The results suggest that, unlike during the earlier phases of Vietnam’s transition experience, monetary factors appear to have become an important determinant of inflation over the last few years possibly because liberalization of administered prices increased the responsiveness of domestic prices to monetary actions; and stronger inflation inertia than in other Asian countries has implied that recent food supply and oil price shocks have resulted in a more permanent increase in core inflation. At the same time, there is no strong evidence to suggest that inflation is a benign manifestation of productivity-driven increases in the prices of nontradables relative to tradables (i.e., the Balassa Samuelson effect), and consequently, there is little reason to believe that current inflation will correct itself in the absence of appropriately restrained macroeconomic policies.

References

Al-Mashat, R., 2004, “Vietnam’s Experience with Rapid Credit Growth and Low Inflation,” (unpublished; Washington: International Monetary Fund).
- Search Google Scholar
- Export Citation
Blinder, A., 1997, “Commentary,” Federal Reserve Bank of St Louis Review, May/June, pp. 157 -162.
- Search Google Scholar
- Export Citation
Blinder, A., E. Canetti, D. Lebow, and J. Rudd, 1998, Asking about Prices: A New Approach to Understanding Price Stickiness (New York, NY: Russell Sage Foundation Publications).
- Search Google Scholar
- Export Citation
Blinder, Christiano, L., J. M. Eichenbaum, and C. Evans, 1996, “The Effects of Monetary Policy Shocks: Evidence from the Flow of Funds,” The Review of Economics and Statistics, Vol. 78, No. 1, pp. 16 -34.
- Search Google Scholar
- Export Citation
Bruno, M., and W. Easterly, 1995, “Inflation Crises and Long-Run Growth,” NBER Working Paper, No. 5698, (Cambridge, MA: National Bureau of Economic Research).
- Search Google Scholar
- Export Citation
Burdekinm, R., A. Enzau, M. Keil, T. Sitthiyot, and T. Willett, 2000, “When Does Inflation Hurt Economic Growth? Different Nonlinearities for Different Economies,” Claremont Colleges Working Paper in Economics 2000–22 (Claremont, California, Claremont McKenna College).
- Search Google Scholar
- Export Citation
Central Institute for Economic Management, 2006, Vietnam’s Economy in 2005 (The Publishing House of Political Theory, Hanoi).
- Search Google Scholar
- Export Citation
Coe, D., and C. J. McDermott, 1996, “Does the Gap Model Work in Asia?,” IMF Working Paper No. 96/69 (Washington: International Monetary Fund).
- Search Google Scholar
- Export Citation
Easterly W., and S. Fischer, 2001, “Inflation and the Poor,” Journal of Money, Credit, and Banking, Part 1, Vol. 33, Issue 2 (May), pp. 160 -178.
- Search Google Scholar
- Export Citation
Fischer, S., 1993, “The Role of Macroeconomic Factors in Growth,” Journal of Monetary Economics, Vol. 32, No. 3 (December), pp.485 -512.
- Search Google Scholar
- Export Citation
Gosh, A., and S. Phillips, 1998, “Warning: Inflation May be Harmful to Your Growth,” IMF Staff Papers, Vol. 45, No. 4, pp. 672 -710.
- Search Google Scholar
- Export Citation
Harris, J., and M. Todaro, 1970, “Migration, Unemployment and Development: A Two-Sector Analysis,” American Economic Review, Vol. 60, pp.126 -142.
- Search Google Scholar
- Export Citation
International Monetary Fund, 2006, World Economic Outlook, April 2006, Inflation and Globalization, (Washington: International Monetary Fund).
- Search Google Scholar
- Export Citation
Ito, T., and K. Sato, 2006, “Pass-Through of Exchange Rate Changes and Macroeconomic Shocks to Domestic Inflation in East Asian Countries,” NBER Working Paper No. 12395 (Cambridge, MA: National Bureau of Economic Research).
- Search Google Scholar
- Export Citation
Khan, M., 2005, “Inflation and Growth in MCD Countries,” Mimeo, International Monetary Fund.
- Search Google Scholar
- Export Citation
Khan M., and A. Schimmelpfenning, 2006, “Money or Wheat?,” IMF Working Paper No. 06/60 (Washington: International Monetary Fund).
- Search Google Scholar
- Export Citation
Khan, M., and A. S. Senhadji, 2001, “Threshold Effects in the Relationship Between Inflation and Growth,” IMF Staff Papers, Vol. 48, No. 1, pp 1 -21.
- Search Google Scholar
- Export Citation
Laxton, D., and P. Pesenti, 2003, “Monetary Rules for Small, Open, Emerging Economies,” Journal of Monetary economics, Vol. 50, No. 5: 1109 -52.
- Search Google Scholar
- Export Citation
Lee, Il Houng, 2005, “Impact of Oil Price Increase in Vietnam and Policy Response,” presentation made at the Institute for Price and Market Research, October 21, Hanoi.
- Search Google Scholar
- Export Citation
Nguyen Tri Hung, 1999, “The Inflation in Vietnam,” CAS Discussion Paper, No. 22, Center for ASEAN Studies, Belgium.
- Search Google Scholar
- Export Citation
Palomba, G., 2006, “Explaining Higher Inflation in Indonesia,” Indonesia Selected Issues, IMF Country Report No. 06/318 (Washington: International Monetary Fund).
- Search Google Scholar
- Export Citation
Peiris, S.J., 2003, “Inflationary Dynamics in Vietnam,” in Vietnam: Selected Issues, IMF Country Report No. 03/381 (Washington: International Monetary Fund).
- Search Google Scholar
- Export Citation
Rudebusch, G., and L. Svensson, 1998, “Policy Rules for Inflation Targeting,” NBER Working Paper No. 6512 (Cambridge, MA: National Bureau of Economic Research).
- Search Google Scholar
- Export Citation
Sarel, M., 1996, “Nonlinear Effects of Inflation on Economic Growth,” IMF Staff Papers, March 1996, pp.199 -215.
- Search Google Scholar
- Export Citation
Tobin, J., 1971, “Money and Income: Post Hoc Ergo Propter Hoc?” in Essays in Economics, ed. by J. Tobin, Vol. 1, Chapter 24 (Amsterdam, North-Holland Publishing Company).
- Search Google Scholar
- Export Citation
Troung Van Phuoc and Chu Hoan Long, 2005, “The Determinants of the Consumer Price in Vietnam: A Quantitative Approach,” (unpublished, Hanoi).
- Search Google Scholar
- Export Citation

ANNEX 1 Specification of the Econometric Models and Data Issues

Vector Error Correction Model (Section C)

A Vector Error Correction Model (VECM) is a restricted Vector Autoregression (VAR) model designed for use with nonstationary series that are known to be cointegrated. Cointegration relations are built into the specification so that the long-run behavior of the endogenous variables converges with their cointegrating relationships while allowing for short-run adjustment dynamics.

The following system was estimated:

\begin{array}{l} Δ \ln C P I_{t} = α_{11} (β_{11} \ln C P I_{t - 1} + β_{12} \ln M 2_{t - 1} + β_{13} \ln N E E R_{t - 1} + β_{14} O u t p u t g a p_{t - 1} + \\ β_{15}) + C_{11} Δ \ln C P I_{t - 1} + C_{12} Δ \ln M 2_{t - 1} + C_{13} Δ \ln N E E R_{t - 1} + C_{14} Δ O u t p u t g a p_{t - 1} + C_{15} + ε_{t}^{C P I} \\ Δ \ln M 2_{t} = α_{21} (β_{11} \ln C P I_{t - 1} + β_{12} \ln M 2_{t - 1} + β_{13} \ln N E E R_{t - 1} + β_{14} O u t p u t g a p_{t - 1} + \\ β_{15}) + C_{21} Δ \ln C P I_{t - 1} + C_{22} Δ \ln M 2_{t - 1} + C_{23} Δ \ln N E E R_{t - 1} + C_{24} Δ O u t p u t g a p_{t - 1} + C_{25} + ε_{t}^{M 2} \\ Δ \ln N E E R_{t} = α_{31} (β_{11} \ln C P I_{t - 1} + β_{12} \ln M 2_{t - 1} + β_{13} \ln N E E R_{t - 1} + β_{14} O u t p u t g a p_{t - 1} + \\ β_{15}) + C_{31} Δ \ln C P I_{t - 1} + C_{32} Δ \ln M 2_{t - 1} + C_{33} Δ \ln N E E R_{t - 1} + C_{34} Δ O u t p u t g a p_{t - 1} + C_{35} + ε_{t}^{N E E R} \\ Δ O u t p u t g a p_{t} = α_{41} (β_{11} C P I_{t - 1} + β_{12} \ln M 2_{t - 1} + β_{13} \ln N E E R_{t - 1} + β_{14} O u t p u t g a p_{t - 1} + \\ β_{15}) + C_{41} Δ \ln C P I_{t - 1} + C_{42} Δ \ln M 2_{t - 1} + C_{43} Δ \ln N E E R_{t - 1} + C_{44} Δ O u t p u t g a p_{t - 1} + C_{45} + ε_{t}^{O u p u t g a p} \end{array}

Dynamic Panel Model (Section D)

In order to explain Vietnam’s relatively high inflation rate compared to other countries in the region, the following model was estimated:

π_{i t} = α_{i} + β_{1} π_{i t - 1} + β_{2} M 2_{i t - 1} + β_{3} y g a p_{i t - 1} + β_{4} N E E R_{i t - 2} β_{5} i m p / G D P_{i t - 1} + γ_{1} V N M d u m m y,

where π_it is current inflation, i indicates the country, and t the time period; π_it-1 is lagged inflation, which captures the inflation-inertia component; M2_it-1 is lagged broad money, ygap_it-1 is the output gap, which captures excess demand pressures, with on period lag, and NEER is the nominal effective exchange rate. Country-specific dummies for Vietnam are introduced in the different regressions to explain how much more or less each of the sources of inflation matters in Vietnam compared to the other countries in the region.

Data Issues

Data availability is a major challenge in analyzing inflation in Vietnam and in the other countries in the region. The need for the real GDP series to calculate the output gap dictated that 2000 was the earliest starting date. In addition, most of the monetary series in many Asian countries suffered from structural breaks after the 1997 asian crisis, while in Vietnam a structural break in the monetary aggregates occurred in 1999, reflecting the switch to a large survey for the collection of monetary data.

Actual quarterly output data, despite the relatively short sample period, are preferable to estimated monthly data constructed by interpolation. Real GDP data in Vietnam are available on a quarterly basis from 1999 onwards.

Prepared by Patrizia Tumbarello (APD).

During January 2003–June 2006, the standard deviation of food price inflation was 5.1 percent in Vietnam, 3.1 percent in ASEAN-4, and 1.3 percent in the newly-industrialized economies (NIEs).

The common minimum wage has been successively raised by 38 percent in January 2003, 20.7 percent in October 2005, and another 28.6 percent in October 2006. Average civil service wages were increased by an additional 30 percent in October 2004. Minimum wages in foreign-invested firms were raised by 39–45.8 percent (42% on average) as of February 2006.

For a more extensive discussion of the cost-push and demand-pull factors, as well as the role of inflationary expectations in explaining the recent behavior of inflation, see Central Institute for Economic Management, Vietnam’s Economy in 2005, pp. 32-36.

See, for example, Blinder, Canetti, Lebow and Rudd (1998).

Although small, the contribution of petroleum prices to the CPI increased from nearly zero in 2001 to more than one percent in 2005.

For a similar interpretation, see, for example, Blinder (1997) who has argued that core inflation is the persistent part of inflation, which is highly correlated with future inflation.

The CPI index was revised in May 2006. The total weight of food and foodstuff was reduced to 42.85 per cent in the new index, down from 47.90 percent under the old index. However, detailed data of the new index are currently unavailable, making it difficult to assess the impact of the latest round of increases in oil prices on core inflation.

The lack of any compelling evidence of a Balassa-Samuelson effect is consistent with the results found in Chapter III below.

Ordinance No.40 on Prices, 2002; Decree No. 170 of December 12, 2003; and Circular 15 of March 9, 2004.

See, for example, Peiris (2003) and Al-Mashat (2004).

The output gap has been defined as actual output, seasonally adjusted, less potential output expressed as a percent of potential output. The potential output has been estimated using a Hodrick-Prescott (HP) filter. To correct for the end-point sample bias typically arising in applications of the HP filter, potential output has been estimated using projected output data.

On the empirical evidence of low pass-through from exchange rate to CPI in emerging Asian countries, see Ito and Sato (2006).

These results corroborate the findings of Palomba (2006), who has carried out similar tests using a slightly different sample of Asian countries that excludes China and Vietnam.

For a recent analysis of the positive effects of globalization on inflation control in emerging markets, see IMF (2006), Box 3.1.

See Annex 1 for a discussion on data issues.

For an analysis of whether the output gap was an important determinant of inflation over an earlier period in a broader sample of Asian economies, see Coe and McDermott, 1996.

The sample includes: Indonesia, Korea, Malaysia, Philippines, Singapore, Thailand, and Vietnam.

Save
Cite
Email this content

Share Link

Copy this link, or click below to email it to a friend
Email this content
or copy the link directly:

https://www.elibrary.imf.org/view/journals/002/2006/422/article-A001-en.xml
The link was not copied. Your current browser may not support copying via this button.

Link copied successfully