ASSIGNMENT SUBJECT MACROECONOMICS topic inflation and the rationality of the quantity theory of money in vietnam

In this assignment, I will provide information about the inflation situation inVietnam in the past and forecast in the future, and compare the inflation rate with changes in some other f

NATIONAL ECONOMICS UNIVERSITY

Faculty of Mathematical Economics

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ASSIGNMENTSUBJECT : MACROECONOMICS

Topic: Inflation and The rationality of

The Quantity Theory of Money in Vietnam

Full name: Le Bao Trung

Student’s ID: 11207312

Class : Actuary 62 Topic: 6

Instructor: Dinh Mai Huong

Hanoi, 2021

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I Introduction 3

II Theory 3

1 Money Growth 3

1.1 Demand for Money 3

1.2 Supply for Money 4

1.3 Monetary Equilibrium 5

1.4 The Quantity Theory of Money 6

2 Inflation 6

2.1 Definition and Causes 6

2.2 Inflation measurement 7

2.3 Cost of expected inflation 7

2.3.1 A fall in purchasing power 7

2.3.2 Shoeleather Costs 7

2.3.3 Menu Costs 7

2.3.4 Relative-price variability and misallocation of resources 8

2.3.5 Inflation-induced tax distortion 8

2.4 Cost of unexpected inflation: Arbitrary redistributions of wealth 8

III Facts in Vietnam 9

1 Inflation in Vietnam in the 2016-2020 period 9

1.1 Inflation rate of Vietnam in the 2016-2019 period 9

1.2 Inflation rate of Vietnam in 2020 11

2 Nominal GDP, Money supply and Velocity of Money growth of Vietnam in 2016 – 2020 period 12

2.1 Vietnam’s Nominal GDP growth 12

2.2 Vietnam’s Money supply growth 13

2.3 Vietnam’s Velocity of money growth 14

3 The rationality of The Quantity Theory of Money in Vietnam 16

4 Factors affecting inflation in Vietnam in the future 17

4.1 Factors increase inflation pressure 17

4.2 Factors decrease inflation pressure 17

IV Conclusion 18

V References 19

I Introduction

Vietnam is considered a country with a stable macroeconomic foundation, which is

an important driving force and factor for rapid and sustainable economic development TheEconomist magazine in August 2020 ranked Vietnam in the top 16 most successfulemerging economies in the world

According to economic theory, growth, inflation, balance of payments,unemployment are important macroeconomic factors that affect the macroeconomicbalance of the economy, in which, the inflation factor is the top concern of any country.After the fact that inflation in Vietnam soared to 18.13%, the highest since 2008 in 2011,our country had successful policies to curb inflation and maintain the low inflation rate atbelow 3,6% in the last 6 years, in the period from 2015 to 2016

In the context that global inflation in 2021 is forecasted to increase quite strongly(maybe at 2.8% compared to 2% in 2020), inflation pressure in Vietnam has also begun toappear In the situation of economic instability because of the epidemic along with a largeamount of money being injected into the economy but low capital efficiency, the stateneeds to take timely actions to control inflation in the future

In this assignment, I will provide information about the inflation situation inVietnam in the past and forecast in the future, and compare the inflation rate with changes

in some other factors to evaluate the rationality of The Quantity Theory of Money whenapplied in Vietnam

II Theory

1 Money Growth

1.1 Demand for Money

Demand for money (MD) : the demand of money is based on the need forexchange, precaution and speculation Determinants of MD comprise of three factors :

MD = f(AE, i, P)

- The aggregate expenditure (AE): the sum of all the expenditures undertaken in theeconomy by the factors during a specific time period The aggregate expenditure determinesthe total amount that firms and households plan to spend on goods and services at each level

of income

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- Price level (P): the average of current prices across the entire spectrum of goods andservices produced in an economy.

- Nominal interest rate (i): the interest rate announced by the bank, it reflects the increase in the amount of money when deposited in the bank

Although several factors influence money demand, one stands out as particularlyimportant: the average level of prices in the economy Money is held by people because itserves as a medium of exchange People can use money to acquire the goods and services

on their shopping lists, unlike other assets such as bonds or stocks The amount of moneythey keep for this purpose is determined by the prices of such items and services Thehigher the prices, the more money is required for a normal transaction, and the moremoney people opt to keep in their wallets and checking accounts That is, a greater pricelevel (lower money value) raises the amount of money demanded

1.2 Supply for Money

The money supply refers to the amount of cash or currency circulating in an

economy This factor is under control of monetary policies and independent from the price

Measures of money supply: the money supply is categorized by various monetaryaggregates including M0, M1, and M2

Coin money, physical paper, and central bank reserves make up the monetary basis,

or M0 M1, the most often used aggregate, includes M0 as well as demand deposits andtravelers' checks M2, on the other hand, includes M1 as well as savings deposits andmoney market shares, and may be used as a measure of inflation when compared to GDP

The policies the central bank uses to change the money supply in the economy:

Open-Market Operation: The activity of a central bank buying or selling government

bonds in the market Through short-term trading of valuable papers, the central bank directlyaffects the available capital of credit institutions, thereby regulating the

money supply Central bank buy government bonds if they want to increase money supplyand sell bonds if they want to reduce money supply.

Discount rate: The discount rate is the interest rate charged to commercial banks

and other financial institutions for short-term loans they take from the central bank Whenthe central bank raise interest rates banks will deposit less money the money supply willincrease

Reserve Requirements: a central bank regulation of the cash-to-deposit ratio that

commercial banks are required to comply with to ensure liquidity When central bankreduce the reserve requirements, banks will loan more and the money supply will increase

Paying Interest on Reserves: when a bank holds reserves on deposit at the central bank,

central bank now pays the bank interest on those deposits The less the interest rate onreserves, the less reserves banks will choose to hold and the money supply will increase

1.3 Monetary Equilibrium

In the long run, money supply and money demand are brought into equilibrium bythe overall level of prices If the price level is above the equilibrium level, people willwant to hold more money than the Fed has created, so the price level must fall to balancesupply and demand If the price level is below the equilibrium level, people will want tohold less money than the Fed has created, and the price level must rise to balance supplyand demand At the equilibrium price level, the quantity of money that people want to holdexactly balances the quantity of money supplied by the Central Bank

The two curves in this figure are the supply and demand curves for money Thesupply curve is vertical because the Fed has fixed the quantity of money available The

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demand curve for money slopes downward, indicating that when the value of money is low(and the price level is high), people demand a larger quantity of it to buy goods andservices At the equilibrium, shown in the figure as point A, the quantity of moneydemanded balances the quantity of money supplied This equilibrium of money supply andmoney demand determines the value of money and the price level.

1.4 The Quantity Theory of Money

- P: Price level (GDP Deflator)

- Y: The amount of output (real GDP)

- MS: The quantity of money

- V: The velocity of money

So, P x Y is total value of goods/services (Nominal GDP) and MS x V is total payments needed

Changes in price level:

%∆P + %∆Y = %∆MS + %∆V

Because the velocity of money is relatively stable over time, when the central bank

changes the quantity of money (M), it causes proportionate changes in the nominal value of output (P x Y) The economy’s output of goods and services (Y) is primarily determined

by factor supplies (labor, physical capital, human capital, and natural resources) and theavailable production technology In particular, because money is neutral, money does notaffect output Therefore, when the central bank increases the money supply rapidly, theresult is a high rate of inflation

2 Inflation

2.1 Definition and Causes

In economics, inflation is defined as a gradual increase in the price of goods andservices in a given economy When the general price level rises, each unit of currency buysless products and services; as a result, inflation equals a loss of money's purchasing power

According to The Quantity Theory of Money, inflation is caused by a rise in thequantity of money, which can occur through a variety of causes in the economy Themonetary authorities can increase the money supply by printing and giving out moremoney to individuals, legally devaluing (decreasing the value of) the legal tender currency,

or more commonly (and most commonly) by lending new money into existence as reserveaccount credits through the banking system by purchasing government bonds from banks

on the secondary market

2.2 Inflation measurement

The Consumer Price Index (CPI), produced by the Bureau of Labor Statistics (BLS), is

the most widely used measure of inflation The primary CPI (CPI-U) is designed to

measure price changes faced by urban consumers, who represent 93% of the U.S

population It’s an average, though, and doesn’t reflect any particular consumer’s

experience

The method of calculating CPI in Vietnam has been applied since 1995 up to now in

accordance with the guidance of the International Labor Organization (ILO), this is also the

standard applied by most countries in the world and is now followed by the International

Labor Organization (ILO) The latest ILO Consumer Price Index compilation guide issued in

2020 Therefore, the CPI calculation method of the General Statistics Office closely reflects

the consumer price movement in the market and ensures comparability with those of the

General Statistics Office data of countries in the world as well as in the region

Calculation of inflation rate based on CPI Use the CPI to calculate the inflation

rate, which is the percentage change in the price index from the preceding period That is,

the inflation rate between two consecutive years is computed as follows:

Inflation rate in year 2 =CPI in year 2−CPI in year 1 × 100%

CPI in year 1

2.3 Cost of expected inflation

2.3.1 A fall in purchasing power

When the general price level rises, a unit of currency buys fewer goods and services

than it used to, so inflation reflects a decrease in purchasing power per unit of currency

If your wage stays the same but prices grow due to inflation, your purchasing power will

dwindle, and you won't be able to buy as much as you could before

2.3.2 Shoeleather Costs

When there is high inflation, the shoe leather cost is the cost of time and effort (or

opportunity costs of time and effort) that people waste by holding less currency in order to

lower the inflation tax they pay on cash holdings These expenses include making multiple

bank trips, not being able to make change, and being unable to make unexpected

expenditures The name stems from the fact that going to the bank and getting cash and

spending it requires more walking (historically, though the introduction of the Internet has

reduced this), thus wearing out shoes more quickly The extra time and convenience that

must be sacrificed to keep less money is a substantial cost of lowering money holdings

2.3.3 Menu Costs

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The expense incurred by a company as a result of adjusting its prices is known asmenu cost The term comes from the expense of restaurants printing new menus, buteconomists apply it to the costs of altering nominal pricing in general Menu expenses, inthis larger sense, might involve upgrading computer systems, re-tagging products, andpaying consultants to devise new pricing methods, in addition to the actual costs ofprinting menus More broadly, the menu cost may be thought of as the sum of information,choice, and implementation costs, all of which result in restricted rationality Because ofthis cost, businesses do not always modify their pricing in response to changes in supplyand demand, resulting in price stagnation.

2.3.4 Relative-price variability and misallocation of resources

Consumers compare the quality and costs of various items and services beforedeciding what to buy They make these judgments to decide how scarce production inputsare distributed among industries and enterprises When relative prices are skewed byinflation, consumer decisions are affected, and markets are less able to allocate resourcesefficiently Assume that the price of pork rises owing to inflation, and all the producersswitch to producing more pork, causing the resources to be misallocated, causing theprices to rise

2.3.5 Inflation-induced tax distortion

Almost all taxes distort incentives, affect people's behavior, and result in a lesseffective allocation of resources in the economy Many taxes, on the other hand, becomeconsiderably more burdensome when inflation is present The reason for this is that whilecreating tax legislation, legislators frequently neglect to account for inflation According toeconomists who have researched the tax code, inflation tends to increase the tax burden onsaved income

2.3.6 Confusion and inconvenience

It's impossible to estimate the price of inflation's uncertainty and inconvenientconsequences We previously addressed how the tax law miscalculates actual incomes inthe face of inflation Similarly, as prices rise over time, accountants miscalculate acompany's earnings Because inflation causes the real worth of dollars to change overtime, calculating a firm's profit—the gap between its income and costs—is more difficult

in an inflationary environment

2.4 Cost of unexpected inflation: Arbitrary redistributions of wealth

Unexpected inflation arbitrarily redistributes wealth from one group to anothergroup, such as from borrowers to lenders When people decide to borrow money or lendmoney, they often consider what they think the rate of inflation will beWhen inflationdiffers from expectations, some groups may benefit, while others may suffer When

inflation exceeds expectations, lenders may suffer a loss, while borrowers may benefit.

Lenders win when inflation is lower than projected, while borrowers suffer

III Facts in Vietnam

1 Inflation in Vietnam in the 2016-2020 period

Inflation rate of Vietnam in the 2016 - 2020 period (%)

in the future, closely working with other macro measures in order to keep average inflationaround 4%, as requested by the National Assembly

1.1 Inflation rate of Vietnam in the 2016-2019 period

In 2016, CPI in December increased by 4.74% compared to December 2015, anaverage increase of 0.4% per month The average CPI in 2016 increased by 2.66%compared to the average of 2015 The increase in CPI in December 2016 compared to thesame period in 2015 and the average increase in CPI in 2016 compared to the average in

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2015 increased higher than the previous year but much lower than the average CPIincrease of some recent years, and still within the target limit of 5% set by the NationalAssembly Core inflation in December 2016 increased by 0.11% over the previous monthand by 1.87% over the same period last year Average core inflation in 2016 increased by1.83% compared to 2015.

In 2017, consumer price index (CPI) in December increased by 0.21% over theprevious month; Average CPI in 2017 increased by 3.53% compared to 2016, below thetarget set by the National Assembly; CPI in December 2017 increased by 2.6% compared

to December 2016, an average increase of 0.21% per month Core inflation in December

2017 increased by 0.11% over the previous month and by 1.29% over the same period lastyear Average core inflation in 2017 increased by 1.41% compared to 2016

In 2018, the consumer price index (CPI) in December decreased by 0.25%compared to the previous month Average CPI in 2018 increased by 3.54% compared to

2017, below the target set by the National Assembly CPI in December 2018 increased by2.98% compared to December 2017, an average increase of 0.25% per month Coreinflation in December 2018 increased by 0.09% over the previous month and by 1.7% overthe same period last year Average core inflation in 2018 increased by 1.48% compared to2017

In 2019, the consumer price index (CPI) in December increased by 1.4% compared

to the previous month, this is the highest increase in the past 9 years, in which the group offood and food services increased by 3.42% due to the epidemic African swine fevercauses a decrease in the supply of pork, and an increase in the price of products processedfrom pork, replacing pork The average CPI in 2019 increased by 2.79% compared to theaverage in 2018, below the target set by the National Assembly, this is also the lowestaverage annual increase in the past 3 years

1.2 Inflation rate of Vietnam in 2020

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