• ABSTRACT Among different channels namely: interest rate, asset price, credit, exchange rate channel are affected by monetary policy, which one plays as a key channel in this mechanism
INTRODUCTION
RELEVANCE AND BACKGROUND OF STUDY
The restructuring of state owned commercial banks (SOCBs) and the establishment of join stock banks (JSBs), had appeared since Vietnam financial reform in the first haft of 1990s Consequently, the finance system of Vietnam has deepened when monetization increased continuously (in 2004, the ratio M2 to GDP was above estimated 70% compare to 25% in mid-1990) Seventy-three percentage of total credit is provided by SOCBs in 2004 The credit market and other parts of financial system to be segmented proceeding JSBs and others small banks supplied credit primarily to private sector, whereas SOCBs almost loaned both sectors equivalently (Camen, 2006)
When Vietnam took part in the World Trade Organization (WTO), lead to the surge of new foreign direct investment and portfolio inflows Globalization, it's synonymous with Vietnam has posed significant challenges to their economy Unfavorable balance of payments is also the major concern Vietnam's financial sector has been explosion since 2000 year only, noticeable in 2007-2008 periods Consequently, Vietnam's credit market grew too hot, the number was estimated about 50 percentage in January 2008, that contributed a positive element to inflation rising, got 14 percentage at this time (Ishii, 2008) And at early months of year 2011, Vietnam's inflation rate accelerated to 13.89 percent in March, peak out at highest in 25 months Moreover, the trade gap increased to $1.15 billion that month after look over $1.11 billion in February (S&P Reporting, 2011 ).
PROBLEM STATEMENT
For facileness, most of economic models usually assume that the changes of economy which affect by financial conditions have just relatively bounded by set of several financial variables They could be risk-free interest rates in short term or government bond rates in long term (Hall, 2001 )
However, once the system of financial develops with high degree, especially in recent years, its impact on the economy becomes wider and deeper Hence, it's quite hard to find the root of problem when the economy is developed, because of some variables may not be indicated For example, the world financial crisis in 2008 had a root from credit sector, typically, mortgage assets crisis in the U.S or the refugee capital of Vietnam security market in 2008 due to the easing monetary policy in previous years
In the past, many economists such as Pintinkin, Gurley, Shaw, etc., emphasized the important role of financial intermediaries and credit markets Modigliani and Papademos (1977) also admitted that the traditional theory of monetary mechanism ignored the functions of financial intermediaries and bank credits Financial intermediaries were strong influence on credit supply than money supply (Gurley and Shaw, 1956) Evidently, credit channel contributes a significant factor and affects directly to decisions of policy makers
Hence, understanding the position of credit channel in financial market is crucial to policy makers In detail, understanding the transmitted mechanism of monetary policy through credit channel is very important As a result, indentify the role of credit channel in monetary transmission is essential for enhancement current policies By that way, it contributes to the achievement of national economic objective
This study aims to identify the role of credit channel in Vietnam's monetary transmission mechanism, specify 1996-2010 period Following the main objective, the thesis:
To analyze whether past value of credit helps predict the money supply;
To examine the impact of credit shocks on money supply, also other macro economies;
To test whether credit shock plays important role in forecasting the error of money supply.
RESEARCH QUESTION
To obtain the above objectives, this thesis will attempt to answer the following questions:
What is the role of credit channel in the monetary policy transmission in Vietnam case over the period 1996-2010?
Does the past value of credit help predict money supply?
How does money supply reaction to credit shock?
Whether credit shocks plays important role in forecasting money supply's error?
To carry out above objectives, this study uses quarterly data from 1996:Ql to 2010: Q3 Econometric techniques and descriptive statistic will be employed as primary quantitative in this research
Descriptive statistic analysis gives an overview of all variables that are used in this thesis Those are including: the distribution, variation, central tendency of all original also changed data Since then, we can a cursory evaluate the quality of employed data Concerning to the econometric techniques of time series data, vector autoregression (V AR) will be employed to answer key questions Due to the data is time series, unit root test is used to examine for stationary of all variables to ensure the validation oft- test and F-test in firstly Next, optimal lag lengths for V AR model is chosen by different criteria to have the best model Granger causality test will help us answer first sub question whether past value of credit is useful to forecast money supply Then, impulse responses and variance decompositions are two popular techniques of V AR model to answer two last sub questions respectively Collecting from those empirical results, we can conclude the role of credit channel in monetary transmission in Vietnam case.
STRUCTURE OF THESIS
The study is organized as following:
Chapter 1 introduces the importance of thesis, relevance and back ground of study, the objectives and research questions And the methodology is presented as briefly in this part
Chapter 2 demonstrates the literature review Firstly, credit channel theory is mentioned as a core of study Secondly, empirical studies about the role of credit channel in monetary policy transmission are presented In addition, the chapter gives overview the Vietnam's monetary policy framework, in which focuses on the credit market
Chapter 3 presents analytical framework, then develop the model which helps us answer key question Finally, data description as well as steps of economic techniques will be mentioned in this chapter
Chapter 4 shows the empirical results and discussion Finally, results comparison is also presented in this part
Chapter 5 give conclusion, suggests some practical policy implications, and discusses the limitations and direction for further studies.
LITERATURE REVIEW
CREDIT CHANNEL THEORY
Credit channel theory is based on the existing of external finance premium, reflected typically by principal agent problem between lender and borrower Bernanke and Gertler (1995) had discussed in some details through two possible linkages, these are the bank lending channel and the balance-sheet channel This thesis will mention two linkages which are relevant to credit channel theory
The bank lending channel: concentrates the variability of loan supply through deposit institutions caused by the effect of monetary policy actions
Banks, that remain dominant information sources in the economy, so that, can overcoming asymmetric information problems and other fictions in credit markets That is a reason why many borrowers depend on bank credit, specially small and medium size enterprises Once this function still remains, the influence of bank lending channel in monetary policy transmission continues its role
In case, the government does expansionary monetary policy, bring to increases the bank deposits from customers or bank reserves; the quantity of bank loans available would be increased, then investment increases, lead to output increases
Conversely, tightening monetary policy is synonymous with reducing bank reserves or customer deposits, which leads to a decreased of quantity of bank loans available Next, reduce investment spending and output decrease as consequently
Another side of credit view, when we mention to the impact of monetary policy to enterprises, small firms suffer bad effects on expenditure than large firms (Mishkin,
1996) The reason is because of more dependent on bank loan with small companies, whereas big companies can access huge capital through stock and bond markets, not necessary via bank channel
Balance sheet channels: focuses influence of monetary policy changing on borrower's balance sheets and income statement
In balance sheet aspect, the changing in company's worth due to the variability of monetary policy tends to raise the adverse selection and moral hazard problems when grant loans to those companies The borrowers have less collateral in case, the probability moral hazard problem happen will high if those firms want to access the loan More details, the company with lower equity prices has tendency to accept risky projects Then, the more risky the firms take, the more probability the firms could not paid back their loans, which leads to bank collapsed and decreased in lending, and also investment spending Meanwhile, the banks request the lenders provide more collateral for their crediting due to net worth declining, hence have an increase the adverse selection problems, and reduce fund for investment as consequences
Here is several ways which monetary policy acts upon on firm's balance sheet:
Expansionary monetary policy, as already dealt with earlier, is the reason of rising in equity stake In this circumstance, adverse selection and moral hazard problems were decreased as well Next, firm's valuation will increase and the sources of capital, which provide for investment, are also higher and lead to increasing in aggregate demand
In other way, lower interest rates by the reason of expansionary monetary policy also cause the firm's balance sheet reformation because of the effect of cash flow Therefore, adverse selection and moral hazard problems can be lessened As a result, capital available for loan will increase, investment spending growth, aggregate output increment finally
Monetary expansion is the reason which brings to the unforeseen increase in the price level, hence raises the net worth of companies and lower adverse selection and moral hazard problems It implicates a rise in investment spending and aggregate output
On the other hand, contractionary monetary policy causes a decline in equity price or reducing in cash flow Therefore, a lower net worth of business firms because of the increase of adverse selection and moral hazard problems, in tum decrease leading to financing investment and consumption.
MONETARY POLICY FRAMEWORK OF VIETNAM
According to "Law on the State Bank of Vietnam", the SBV is a body of government and the central bank of the Socialist Republic of Vietnam The Law also stated that National Assembly and the government are responsible to give decisions, also its supervisor relevance to monetary policy The government has function to prepare a plan, including projection annual inflation rate for monetary policy It determines the amount of liquidity which to be injected in the economy The government has to report the progress on implementation of monetary policy to National Assembly The role of SBV includes exercise monetary policy, as designed by government In addition, the SBV will conduct the state's management through monetary and bank activities and act as currency issuing bank, bank of credit institutions, and bank of government Those activities have goal to stabilizing the currency value, preserve banking activities and banking system, and adapting with state budget and economy growth within the context ofthe country's socialist orientation (State Bank of Vietnam, 2003)
Base on SBV Law, SBV operates as a part of Vietnamese government, while the National Assembly plays an important role in monetary decision A strong intervened of government; also National Assembly in the implementation money policy exhibits that the limited ofSBV's independence instruments (Camen, 2006)
2.2.2 MONETARY POLICY STRATEGY AND INSTRUMENTS
The Vietnam's monetary policy strategy is extracted from five years plan of Social and Economic Develop Strategy And the government has duty to formulate the action plan for implementation Not only the targets for injection of liquidity into the economy are set, but also M2, credits, deposit and other target related will be determinate as important part of government's action plan (Camen, 2006)
The SBV, as a part of government, bases on macroeconomic and monetary objectives, announces annual targets for total liquidity and credit to the economy Each year, the SBV arranges a report the implementation monetary policy of that year and monetary outlook for next year Then, the SBV submits it for the government consideration and approval Finally, government will submit this report to National Assembly for approval, after consulting with National Monetary Policy Advisory Board 1 (Hung and Pfau, 2008)
Regarding to monetary instruments, a number of indirect tools have been introduced include reserve requirement, refinancing, discount financing facilities, open market operation and foreign exchange interventions
SBV has applied reserve requirement in various forms since 1990s This instrument proves its important role on money market regulating in past Currently, required
1 National Monetary Policy Advisory Board (NMPAD): is broad including the Governor ofthe State Bank, the Minister of Finance, and other experts reserves are distributed into classes depend on deposit maturity, the sectoral focus of bank, and the kind of currency deposits (domestic or foreign currency) Deposits of less than a year are higher than those for more than a year and interest subsidized for banks when credit for agriculture sectors or People Credit's Fund (Camen, 2006)
In 2008 year, reserve requirement was used as an effective tool in order to constrain inflation due to strong economic and monetary movements both domestically and internationally On February 2008, the SBV raised the reserve requirement ratio by 1 percentage point applicable to both local and foreign currency deposits in most of credit institutions (SBV, 2008) In recent years, with goal to prevent economic down tum, the SBV decreased required reserve applicable to VND deposit for below 12 months twice in 2009 from 6% to 5% and to 3%, exception for Vietnam Bank for Agriculture and Development reduced this rate from 3% to 2% and 1% (SBV, 2009)
In 2010 year, SBV continued to keep reserve requirement ratio at low level; in specific; 3%, 1% for VND deposit below and more than 12 months respectively For foreign currency, SBV also adjusted down to help credit institution increase foreign currency funding (SBV, 201 0)
OMOs have been used by State bank since July 2000 Over those years, this instrument proves its importance and becomes a single most significant monetary instrument for controlling liquidity OMOs were flexibly managed in line with other monetary policy instruments, thus helping to stabilize the money market SBV conducted by issuing SBV's compulsory bills, higher base interest rate, in particular, increasing 182-day and 364-day bills with the annual rates of7.5% and 7.75% respectively for sake of inflation control at first 7 months of 2008 (SBV, 2008) The first half of 2009, SBV had offered to purchase valuable papers for maturity 14-days, that supplied short-term capital and facilitated credit institutions to meet capital need for economic stimulus programs
(SBV, 2009) However, this action of SBV was unsuccessful because of low demand of fund and surplus financial resources at that timing Continuity, OMOs were conducted to support credit institutions in first 9-months of 2010 by purchasing valuable papers, but increased interest rate for those papers due to high inflation pressure at 3-months end of2010 (SBV, 2010)
Besides changing reserved requirement, a refinancing and a discount facility are another tool ofSBV's discount policy The form of refinancing rate and rediscount rate are fairly similarly However, rediscount rate is set by SBV that base on collateral valuable papers such as draft, promissory note, bond etc Commercial banks use those valuable papers as collateral to access funds form SBV While refinancing rate is given rely on commercial bank's loan by SBV Commercial banks use those loans as collateral for their loan from SBV Because of this difference, refinancing rate is usually higher than rediscount rate in practical Recently, the SBV has used refinancing rate as a mean of supplementing ensure short term lending and liquidity to credit institution in 2010 SBV provided mainly 1 to 2 months refinancing to guarantee liquidity of economy And at late 2010 year, the SBV conducted refinancing in order to promptly adapting the high demand for deposit withdrawals of economic organizations and individuals during Lunar New Year (SBV, 2010)
Historically, only the SBV and two SOCBs provided almost all financial services for Vietnam's financial system In 1988, two years after Doi moi, the SBV was separated and operated as the central bank in which specializes in the monetary policy and financial supervision Next step of financial reform is appearance of join stock of
• commercial banks and foreign banks in 1991, 1992 respectively To fulfill policy finance, Development Assistance Fund was established in 2000 year Vietnam's financial market connects closely in non-commercial lending in past, in which agriculture sector dominance (World Bank report, 2006)
In the World Bank's report related to the state of Vietnam's capital market in 2006 commented that Vietnam's banking sector had expanded rapidly, mostly by supplying loans to private sector SOCBs still remain dominant for credit to economy Despite of sector reform, the banking sector remains financially weak and requires reinforcement to enhance its stability and lending capacity (World Bank report, 2006)
Table 2.1: One decade and Vietnam's credit
Credit to Economy (growth rate) 23% 25% 32% 39% 35% 23% 50% 28% 45%
Source: Calculated from IMF-IFS and GSO data
In the banking sector credit, credit to the economy rose from VND 155 trillion in 2000
(35 percent GDP) to VND 2,690 trillion (136 percent GDP) in 2010 (as shown table 2.1 ) Only one decade, the supplied credit increased seventeen times Noticeable, Vietnam's credit growth was too fast since late 2007 (50 percent credit's growth) This phenomenon could be explained by a massive capital inflows and real estate price bubbles as collateral loan (Vietnam Plus News, 2009)
Vietnam's credit growth 2011 and orientation in 2012
According to Reuters Article, total outstanding loans in Vietnam's banking system grew 10.9 percent last year from 2010 That is a lowest rate of credit growth in one decade recently This number was well smaller than a target 15-17 percent, which had been cut under 20 percent initially in 2011 year Meanwhile, deposit growths 8.89 percent from 2010 and money supply expanded an estimated 9.27 percent in monthly report ofSBV
EMPIRICAL LITERATURE
In recent years, many empirical studies related to the role of credit in monetary policy transmission have been done At beginning, Bemanke and Blinder (1988) were raised this problem in famous paper "Credit, Money and Aggregate Demand" IS/LM model as simple tool which they employed to measure variance of money demand shock And they introduced CC (commodities and credit) curve that had shape like IS/LM curve to test the role of credit channel through bank lending channel when shock happening They divided two sub-samples (1974:1-1979:3 and 1979:4-1985:4) and concluded that the variance of money-demand shocks was much smaller than that of credit-demand shocks during the first sub-period but more important relative in 1980's
A question about the role of credit channel and monetary transmission was raised after that And Ramey (1993), had been conducted this topic in his study since Ben Bemanke wrote his paper He used monthly sample size of American from 1954:1 to 1991:12 to answer the question whether had the relative importance of money and credit channel in monetary transmission mechanism With purpose analyze this mechanism in detail the author employed dynamic stochastic general equilibrium model and eight variables (including: industrial product, Ml, M2, bank loans, Federal rate, 6-month commercial rate, 3-month Treasury rate, inflation rate) As the result, he denied the role of credit channel when concluded money channel is much more important than credit channel in direct transmission policy shock during that time After that, Bemarke and Gertler (1995) postulated credit channel was important component in "black box" 2 • Two linkages of credit channel are bank lending and balance sheet channel were presented very details Most of studies afterwards take this idea as main orient when want to examine credit role In order to view the responses to policy shocks, vector autoregression method operated as efficiently tool in study They recognized credit channel could indentify significant cost due to the capital effects of the pure neoclassical type
In his investigation following Korea's financial crisis, Kim (1999) explored the role of credit channel in monetary policy transmission He based on monthly data from 1993:1 to 1998:5 and combined three methodologies: a narrative approach, disaggregated bank data, disequilibrium model to test for bank lending channel For econometric specification, standard vector autoregression was employed to identify whether loan supply are really important The result provided persuadable proofs of the important role of credit channel afterward consequence of the financial crisis
Following years, many researchers, did the study nearly the same that topic However, many countries which had various characteristics, so those results also were diverse Unlike empirical working previous, Warner and Georges (2001) offered novel test of credit view of monetary transmission by using stock market return They estimated the abnormal return for daily stock market return of common shares ofU.S manufacturing firms Research's finding showed that there was no consistent relationship between abnormal stock returns and credit constraint both two periods (recessionary: 1990-1991 and expansionary: 1993-1994) Similarly effect with Warner and Georges, in his empirical study, Suzuki (2004) had study whether lending vie~ was correct in the case of Australia during 1985:Q1-2000:Q2 The author found that lending channel is less dominant in Australia, because of some features of Australia bank's behavior In another view, Lown and Morgan (2002), Disyatat and Vongsinsirikul (2003) shed light on credit effects in U.S and Thailand economy respectively For Lown and Morgan paper, the authors looked for evidence of both type of credit effects by using information on bank's commercial credit standards as proxy for bank credit availability The applied vector autoregression (V AR) model extended to resolve
"mystery" 4 • One remarkable of this study, loan market was classified by two forms; those are classical market and augmented market By market discrimination, the author could find out the role of credit standard in U.S economy The empirical concluded that the dynamic of commercial credit standards matter a lot both loans and output Take on typical econometric methodology, VAR model, Disyatat and Vongsinsirikul engaged
3 The economists who supported the view: bank loans play important role in monetary policy transmission mechanism
4 Lown and Morgan (2002) treated credit effect as mystery three main variables of Thailand economy (real output, the CPI, and 14-day repurchase rate) through 1993-Ql to 2001-Q4 to measure the intensity of money market transmission to private areas The study realized that investment was significance to monetary shocks and bank played as essential adhesive for monetary policy implementation in reality
While explored the variation financial environment after inflation targeting in Thailand, Charoenseang and Manakit (2006) realized that transmission of monetary policy through the credit channel was dominant than interest rate channel during June-
2000 to July-2006 Typically, that is dependent capital sources of economic activities on bank lending in Thai financial market Once again, the authors confirmed the important role of commercial bank lending in Thai economy
In the same year, Podpiera (2007) had employed commercial banks data to study the impact of monetary policy shocks on loan market in Czech case; meanwhile Kubo.A
(2007) concentrated credit channel when investigate the monetary transmission mechanism in Thailand, highlighting credit channel Both empirical studies supported the important role of credit channel at research timing More specifically, Podpiera adopted Kashyap and Stein model, with balance sheet data of Czech banks covers 1996:Ql to 2001 :Q4 The empirical finding showed that the changes of monetary policy alter the growth rate of loans, special period 1999-2001 And Kubo used a structure vector autoregression (SV AR) to learning the effect of exogenous monetary policy shock influence to price and other domestic macroeconomic Monthly observations between May-2000 to December-2006 were conducted and contained five variables: customer price index, industrial production, producer price index, inter-bank overnight lending rate and private credit aggregates From the paper's result, the authors realized that behind the success the BOT (Bank of Thailand's), credit channel contributed as important factor during that time Moreover, the empirical found that negative movement effects on import demand when examined the impact of monetary policy shock on international variables in SV AR system
Balazs Egert (2009) had been investigated the achievement of research in the context of monetary transmission mechanism, in which Central and Eastern Europe concentration The paper showed that a reducing in inflation rate is basic factor made the degree of exchange rate transmission downward over time And credit channel demonstrated as a key channel in monetary policy transmission, whereas asset price channel could not prove its powerful in flat of stock and bond market The same that work of Balazs Egert, Fiorentini.R and Tamborini.R (2001) had raised a ring to Italy's policy makers when realized the importance role of credit supply during past decade's research
Once again, with objective to examine the monetary policy transmission for India case Abdul (2009) also employed V AR model combined with macroeconomic variables like: bank rate, repo rate, reserve repo rate; etc The same previous study, researcher admitted that bank lending channel was crucial important in monetary policy transmission to Indian's economic activities Furthermore, Fed's rate was recommended inclusion when analysed in monetary shocks, because of its strong affected to emerging country like Indian Nearest study, Catao and Pagan (2010) employed an expectation-augmented SV AR to study monetary transmission in Brazil and Chile Most of data which they accounted from IMF's International Financial Statistics (IFS) and the Brazilian Planning Ministry Research Institute (IPEA) and Central Bank of Chile They realized the important role of a bank-credit channel when incorporated key structural features of Emerging Market economies by structure model They also exhibited when the typical size of credit shocks happens would robust effects on output and inflation, especially in Chile where the penetration in bank system was higher
In the context of credit role in monetary policy transmission in Vietnam, there are has been not much study related to this topic Only in 2008, in line with this subject, in spite of not directly touch on the role of credit problem, Hung and Pfau (2008) have been analyzed the monetary transmission mechanism of Vietnam The authors employed the vector autoregression approach (V AR) which focused on the reduced- form relationship between money, real output, price level, real interest rate, real exchange rate and credit A remarkable conclusion was the weakness connection between monetary policy and each channel in Vietnam case and the credit and exchange rate channel played an important role than interest rate channel
In short, this chapter has toughed core of thesis through credit channel presentation Credit theory is explained by external finance premium Monetary policy shock can influence loan market through bank lending channel and balance-sheet channel Regarding to Vietnam monetary policy framework; National Assembly acts sovereign monetary policy activities whereas SBV exercises the policies as orientation Reserve requirement, OMOs, discount policy are main monetary instruments of Vietnam In empirical literature part, a majority empirical study recognizes the important role of credit channel despite of different country or econometric technique However, there is existing several findings not support this idea
CHAPTER 3: MODEL SPECIFICATION AND DATA
This part will include the analytical framework aim to give an overview about methodology which be conducted in my thesis Next, V AR model will be introduced as the key methodology to test the role of credit channel in monetary policy transmission in Vietnam And finally, the steps of estimation which are employed in this thesis, are briefly explained.
ANALYTICAL FRAMEWORK
Rely on theory and empirical studies, an analytical framework is conducted below
When Vietnam's government implements new monetary policy through money supply adjustment, this will be transmitted four channels; namely; interest rate channel, exchange rate channel, asset rate channel and credit channel All channels will affect macro economy variables such as output, inflation through different ways as theory Asset channel does not work as expected because of inexperience stock market in Vietnam; hence, I do not analyze that channel in the study Otherwise, Vietnam's capital mobility had controlled strictly in past Capital inflow or outflow is mainly driven by interest rate in Vietnam Other words, Vietnam's capital mobility is imperfect, exchange rate channel does not including in my paper Lastly, interest rate channel and credit channel are consider in my thesis, in which concentrate the role of credit channel in the transmission of monetary policy in the case of Vietnam Two markets are classical market (without credit) and augmented market (with credit), that are introduced to explore the credit role V AR model will be employed both markets through three tests, they are Granger causality, impulse response, and variance decomposition From the collected results, we can realize the differences between two markets At last, the role of credit channel in monetary policy transmission mechanism will be indentified.
MODEL SPECIFICATION
In order to meet the objective thesis, Vector autoregression (VAR) model will be developed to answer a question: whether credit channel is key factor in monetary ãpolicy transmission in the case of Vietnam
Following the result of Stock and Watson (2001), V ARs comes in with three varieties: reduced form, recursive and structural The thesis uses V AR approach and focusing on reduced form as convenient method to reap its targets
A reduced form describes each variable as linear function of its own past value and the past value of all other variables A reduced form ofVAR model can be derived as:
Yt is an m-dimensional vector of endogenous variables
(L) denotes vector polynomial of lag operator with optimal lag order;
Et is assumed to be vector white noise residual
The error term (Et) in the regression is the unpredicted movements in the variables after taking its past value into account Each equation is estimated by ordinary least squares separately and the number of optimal lagged value will be resolved by different methods
The variables used for this thesis are quarterly from 1996 :Q 1 to 2010 :Q3 Because of a specific characteristic of Vietnam, hence, we are hardly to access data for longer period Those variables are M2, customer price index, domestic credit, real industrial output, refinancing rate, lending rate Table 3.1 will describe in details the definition, also the sources of data in briefly Those macroeconomic variables represent a parsimonious but potential complete for macroeconomy in the case of Vietnam There have several motivations for choosing this particular set of variables As the work of Romer and Romer ( 1990 ), a decreased in the quantity of reserves leads to a reduction the quantity of loan availability Furthermore, that reduction in stock of reserves has caused by contrationary monetary policy M2 is chosen because of it is the most widely used measures of money and policy shock in Vietnam case And refinancing rate is
• another tool of State Bank of Vietnam to tighten monetary policy (Hung and Pfau,
The customer price index is also included with purposes of inflation because the inflation rate is known as important predictive power for output Certainly, domestic credit variables must be included in the model to measure supply loan in domestic economy Similarly, lending rate is an important component in transmission mechanism of policy that has already mentioned at theory section GDP is the typical variable to measure the economic growth for one country, however, in the case of Vietnam, this data only exists since 2000 year Hence, real industrial output will be employed as a proxy of GDP In the empirical paper of (Hung, L.V and Pfau, W.D.,2008) also used this way in VAR model to analysis the monetary transmission in Vietnam Spurious regression need be controlled of all variables, because Asteriou and Hall (2007) suggested that most of macroeconomic time series are trended, means that they are non-stationary
Base on the resulting of empirical study ofLown and Morgan (2002) had done to look for evidences the role of credit channel in U.S case They classified loan market into two scenarios: a classical market with quantity and price and augmented market with credit included We will apply this improvement in Vietnam case: a classical market (comprising: customer price index, money-quasi, industrial output, refinancing rate and lending rate) and augmented market with including credit as proxy for loan supply or domestic credit to economy.
DATA SOURCES
M2denoted broad of money stock and are defined by formula:
According to IFS's definition in 2009, M2 comprises money (Ml) and saving, time deposit in national currency and demand deposits in foreign currency, other than those of the central government, with other depository corporations
CPI denoted consumer price index The indices are calculated by 37 largest provinces that presenting 8 economic regions and the weights is derived from the 2004 Vietnam Household Living Standard Survey (IMF world and country noted, 2009)
CREDIT denoted domestic credit It is the sum of credit to the nonfinancial public sector, credit to private sector and other account
OUTPUT denoted real industrial output As already represented, Vietnam's industrial output is used as proxy for GDP, due to data limited
M2 Broad money stock IFS-IMF
CPI Customer price index IFS-IMF
CREDIT Domestic credit to economy IFS-IMF
OUTPUT Real industrial output Vietnam GSO
REF IN Refinancing rate IFS-IMF
LR Lending Rate IFS-IMF
REFIN symbolized refinancing rate That is the rate charged by the State Bank of Vietnam on its lending to facilities to all credit institution (IMF world and country noted, 2009)
LR symbolized lending rate This index is calculated by average rates at the end of period on short-term working capital loans for four large state-owned commercial banks (IMF world and country noted, 2009)
Excepting for output that is extracted from Vietnam General Statistic Office, these variables are taken from the International Monetary Fund's (IMF) International Financial Statistic (IFS).
STEPS OF ESTIMATION
Stock and Watson (200 1) stated that due to the complicated dynamics in the V AR, below statistics are more informative than estimated V AR regression coefficients or R 2 statistics
Stationary and unit-root test: According to Gujarati (2003 ), stationary time series are so important, because if a time series is non-stationary, its behavior only for the time period under consideration And if we regression with non-stationary time series may have no meaning, called "spurious" as usual Hence, it is necessary to test stationary for all variables before we apply V AR model
There have various formal statistical tests for unit-root problem Among them, Augmented Dickey Fuller (ADF) and Philips-Perron (PP) test are preferred than in which includes extra lagged terms of the dependent variable in order to eliminate autocorrelation
The Granger causality test: is the second step when regress V AR model And this test has been popular in economic policy analysis It is a useful tool to check the significance of the coefficients X1 can be predicted accuracy by using the past value of
Yt variable rather than not using such past value, or causality represents the ability of one variable to predict another variable
The impulse response and variance decomposition: Impulse responses express the response of current and future values of each variable to a one unit increase in the current value of one ofVAR errors This experiment implied the changing of one error, while holding the others constant Moreover, it also plotted± 1 standard error bands, which yield an approximate 66 percent confidence interval for each impulse response And with forecast the error decomposition econometric tool, we can see the percentage of the variance of error made in forecasting a variable due to a specific shock at given horizon (Stock and Watson 2001)
FINDING AND DISCUSSION
DESCRIPTIVE STATISTIC
This part reports the descriptive statistic of all variables of original data, also changed
It summarizes the mean, median, max, min, standard deviation and count of each variable
Table 4.1: Description statistic ofvariables Variables Mean Median Maximum Minimum Std Dev Obs
Source: Calculated from IMF-IFS and GSO data
The standard deviation ofCPI, CREDIT, M2, and OUTPUT are too high, as well as the large spread between maximum and minimum point indicates that the high volatility during this time (table 4.1 ) Therefore, the estimation results base on their original value can be unreliable By transforming to logarithm form of variables and multiplying by 100, or estimating those variables in percentage changes otherwise makes the standard deviation ofthem drop significant
More details, Figure 1 a&b in appendix helps us overview glance for original data in this thesis The domestic credit supply and quasi-money have same the trend, extending also increasing continued and sharply, special after 2007 year While the incremental output changes not much As have already mentioned in Chapter 2, we can explanation for increasing sharply of credit by a huge capital inflow and estate price bubbles.
UNIT ROOT TESTS
Supporting of Asteriou and Hall (2007) commence that macro economic variables usually have trended Both of two tests, Augmented Dickey-Fuller (ADF) and Phillip- Perron (PP), showed that all variables are non-stationary (Table 4.2 & 4.3)
Table 4.2: Augment Dickey-Fuller test
Source: Calculated from IMF-IFS and GSO data
Meanwhile changed data are stationary; excluding CL _ CPI variable has not satisfied criteria to conclude stationary at ADF test However, it is satisfied at PP test case Therefore, those data can be employed to find the keys answer of thesis
Variables Exogenous t-statistic p-value Data in Level
Source: Calculated from IMF-JFS and GSO data
Concern to the optimal lag problem for V AR model, different criteria are used to determine
Table 4.4: Optimal lap-Classical market
Lag Logl LR FPE AIC sc HQ
Source: Self calculation by using Eviews
Table 4.5: Optimal lap-Augmented market
Lag Logl LR FPE AIC
* indicates lag order selected by the criterion
LR: sequential modified LR test statistic (each test at 5% level)
HQ: Hannan-Quinn information criterion sc
As shown at table 4.4&4.5, various statistical methods can be used to choose the optimal lag length for our model But AIC and SCare known two most important ones With aim to minimize an "information criteria", the optimal number of laps is five based on the minimum AIC criteria both two markets So that, I decide to choose five lags for two cases when apply V AR model.
VARREGRESSION STATISTICS FOR CLASSICAL AND AUGMENTED
Regression statistics for VAR with a classical market are presented at table 4.6 The numbers in this table are p-values when run V AR Granger Causality test include 5 lags The null hypothesis states that independent variable does not cause dependent variable Some of relationships may be revealed interesting matters Lagged values of most of variables are highly significant predict output at 5 percent level, excluding lending rate at 10 percent but output does not Additionally, lending rate does not help to predict money-quasi, but it is useful about forecasting consumer price index, output, and refinancing rate at 10 percent level Even, refinancing rate contains not much
information to predict remain macro variables at 1 0 percent significant level, excepting output And what happen with money supply, it does not Granger cause lending rate, however it is useful for predict output, also price level and refinancing rate at 10 percent level For long time, from the late 80's to 2000 year, Vietnam's interest rate mechanism tends to maintain positive real interest rate, as a solution of inflation control (Dung, 2010) Then, this objective had been achieved Sometimes, deposit rate was higher than lending rate, for instance, in March 1989 the spread between interest rate on industry loans and three months household deposit was minus 1.5 percent (IBP USA, 2005) Since August 2000, the SBV replaced the ceiling mechanism with the base interest rate mechanism combine with amplitude with this rate Under this mechanism, the SBV could limit the lending rate charged by banks (IBP USA, 2005) With actual situation of Vietnam, obviously, lending rate is not liberalized in Vietnam until recently, so can not reflected the demand and supply in money market (Hung and Pfau, 2008) Notably in market without credit, no independent variable in classical market is Granger cause for money supply The absence of a strong correlation between lending rate and money supply, those macro variables and money supply suggests that classical market might be missing something
Table 4.6: VAR Regression Statistic- Classical market
Classical credit V AR Granger- CausalityTest Market
DeQendent Variable IndeQendent vars CL CPI CL LR CL M2 CL OUTPUT CL REFIN
Source: Calculated from IMF-IFS and GSO data
Table 4.7: VAR Regression Statistic- Augmented market Augmented V AR Granger- CausalityTest
CL_LR CL_M2 CL_OUTPUT
Source: Calculated from IMF-IFS and GSO data
Note: The reported are p-value
Continue with augmented market, with credit variable appearance Some findings may be familiar with credit channel literature The lagged values of credit are strongly significant in forecasting money supply (the p-value is zero) But credit Granger caused neither output nor price level (p-value are 0.67 and 0.19 respectively) The result implies that State Bank of Vietnam used credit as mainly channel to inject liquidity into money market Price level is another usefully ones to forecast money supply at 5 percent level At augmented credit market, lending rate still does not predict output and a significant Granger cause either money policy shock or credit but somewhat weaker (p-value is 0.1 or 10 percent significance) However, this improvement compare to above market of lending rate's result has proved the crucial role of credit appearance in case Price level and refinancing rate together Granger caused output Output and lending rate help predict credit at 10 percent significant, whereas M2 fails to forecast either credit or output
In general, we can draw some worth findings from regression statistic Firstly, V AR results with classical market might be unduly explained monetary transmission and lending channel operating, while augmented model, including credit, highly significant in forecasting money supply Secondly, the role of lending rate seems overshadowed money market regulation in model without credit; however; its role seems to be improved in model with credit Thirdly, price level and lending rate are second and third variables respectively that useful to predict money supply beyond credit.
IMPULSE RES PONES AND VARIANCE DECOMPOSITIONS
Let's look at the dynamics implied by these regression estimates and concentrate that shocks to monetary policy as well as to credit variables have on the macroeconomy Following the literature, in the case of Vietnam, we indentify the changes in monetary policy with shocks to the money supply or M2
Figure 4.1: The impulse response functions for classical market
Response ofCL_CPito CL_LR Response ofCL_CPI to CL_M2 R pon ofCL_CPI to CL_OUTPUT Response ofCL_CPI to CL_REFIN
R.eponae ofCL_LRto CL_CPI Reapon.eofCL_LR to CL_LR Response of CL_LR to CL_M2 Response ofCL_LR to CL_OUTPUT Respon ofCL_LR to Ct_REFIN
Response of CL_M2to CL_LR Respon.e ot Cl_MZ to CL_M2 Response of CL_M2 to CL_OUTPUT
Response ofCL_OUTPUT toCL_lR Response ofCL_OUTPUT ằ CL_OUTPUT ã~ I
R"ponu ofCL_REFINto Cl_CPI Response of CL_REFIN to CL_LR Response of CL_REFIN to CL_OUT PUT R••ponse of CL_REFIN to CL_REFIN
Source: Calculated from IMF-IFS and GSO data
The monetary policy shock, shown in the third column, third row, appear as a sharp, drop dramatically form 4.46 at first quarter to (0.006) third quarter, a big tightening nowadays The output adjusts after one lag (mean second quarter) and fluctuates much more than M2 has done The result reveals that output reactions fairly sensitive to monetary shock but not one for one This response happens for two quarters, and recovers the growth since fourth quarter afterward The trough in output is (1.32) percent below the pre-shock level 5 • The lending rate reacts positive to money shock after one quarter, obtains 2.2 percent at peak at sixth quarter However, it brings down since then during three quarters while M2 still maintains tighten policy at that time Price level also reacts slowly when M2 shocks happening, after fifth quarter Response of refinancing rate to money shock also occurs one quarter and attains 3 8 percent at peak
Money supply also responses positive to decreasing in lending rate after one quarter (third row, second column) but short time According to theory, the contrationary money policy causes rise in lending rate, thus restrains investment, which decreases aggregate demand and output in tum But this response does not following sometimes
In past, the data of two variables have exhibited the explanation for abnormal relationship between them While M2 increases continuous during that time, the performance of lending rate does not follow as literature In particularly, lending rate is constrained at 14.4 percent level in 1998 year when M2 growths continuous And this phenomenon happens once again from 2002: Q3 to 2008: Q3 which has causes from bad credit for real estate or financial investment (Dung, 2010) The output's response with lending rate shocks happens since second quarter but maintains one quarter only For output shocks, money supply reacts strongly after one quarter only (third row, fourth column)
These reactions are consistent with the regression statistic; output is highly sensitive to monetary shock; the impact of lending rate shock on money supply is somewhat weak
Figure 4.2: The impulse response functions for augmented market
R11pon11 oiCL_REFW b CL_CPI
Rnpon11 ofCL_LR bCL_CREDIT
Rnpon oiCI._RB=N lo CL_CREDIT
Response to Choles!