Econometrics report determinants of inflation rate a panel analysis of asian economies from 2011 to 2021

This study aims to investigate the dependency of the fluctuation of inflation rate of Asian countries on seven indicators, including Broad Money Growth, GDP Deflator, Exchange Rate, Interest Rate, Wage and Salaried Worker, Population Growth and Countries Income Levels from 2011 to 2021 with the econometrics approach. The researchers collected data from World Bank, host countries’ Statistic Department, Asian Development Bank, Trading Economics and analyzed data using STATA software to carry out Pooled Ordinary Least Square regression with DriscollKraay standard errors. The findings showed that monetary factors (Board Money Growth and Interest Rate) exert a more considerable impact on the fluctuation in inflation rate than other variables in the model. Overall, the regression model is statistically significant with 1% significance level, and six independent variables (Broad Money Growth, GDP Deflator, Exchange Rate, Interest Rate, Wage and Salaried Worker and Countries Income Levels) have statistical impact on inflation rate, at 1% and 5% significance level, except for Population Growth rate. After reporting and discussing the results in detail, the authors proposed policies at the governmental level with the aim of controlling the inflation rate at a consistent level and stabilizing the economy for Asian countries. Keywords: inflation, econometrics, panel analysis, Asia.

   MIDTERM ASSIGNMENT 

  Module: Econometrics 2

DETERMINANTS OF INFLATION RATE A PANEL ANALYSIS OF

ASIAN ECONOMIES FROM 2011 TO 2021

Class: KTEE318

Group:

Instructor: Dr Đinh Thị Thanh Bình

Hanoi, June 2023

This study aims to investigate the dependency of the fluctuation of inflation rate

of Asian countries on seven indicators, including Broad Money Growth, GDP Deflator,Exchange Rate, Interest Rate, Wage and Salaried Worker, Population Growth andCountries Income Levels from 2011 to 2021 with the econometrics approach Theresearchers collected data from World Bank, host countries’ Statistic Department,Asian Development Bank, Trading Economics and analyzed data using STATAsoftware to carry out Pooled Ordinary Least Square regression with Driscoll-Kraaystandard errors The findings showed that monetary factors (Board Money Growth andInterest Rate) exert a more considerable impact on the fluctuation in inflation rate thanother variables in the model Overall, the regression model is statistically significantwith 1% significance level, and six independent variables (Broad Money Growth, GDPDeflator, Exchange Rate, Interest Rate, Wage and Salaried Worker and CountriesIncome Levels) have statistical impact on inflation rate, at 1% and 5% significancelevel, except for Population Growth rate After reporting and discussing the results indetail, the authors proposed policies at the governmental level with the aim ofcontrolling the inflation rate at a consistent level and stabilizing the economy for Asiancountries

Keywords: inflation, econometrics, panel analysis, Asia.

Chapter 1 THEORETICAL FRAMEWORK 8

1 Overview of Inflation 8

1.1 Definition of Inflation 8

1.2 Classification of Inflation 8

1.3 Causes of Inflation 9

2 Overview of Determinants of Inflation rate 10

2.1 Board money growth 10

2.2 GDP Deflator 10

2.3 Exchange rate 10

2.4 Interest rate 10

2.5 Salaried workers 11

2.6 Population growth 11

2.7 Countries Income Levels 11

3 Literature review 12

4 Research hypotheses 13

Chapter 2 METHODOLOGY AND MODEL SPECIFICATION 14

1 Methodology 14

2 Theoretical model specification 14

2.1 Model specification 14

2.2 Variables explanation 15

3 Data statistical description 15

Chapter 3 ESTIMATED MODEL AND STATISTICAL INFERENCES 18

1 Estimated model 18

1.1 Diagnosing the problems of the model 18

2 Hypothesis testing 21

2.1 Significance of independent variables 21

2.2 Overall significance of the model 21

3 Mechanism relationships between variables 21

3.1 Broad money growth 21

3.2 GDP Deflator 22

3.3 Exchange rate 22

3.4 Real interest rate 22

3.5 Wage and salaried workers 23

3.6 Population growth 23

3.7 Countries Income Levels 23

4 Recommendations 24

Table 1.1 WB countries classification in terms of income (2022-2023) 11

LIST OF FIGURES

Macroeconomics holds the theory that the overall level of price in an economyadjusts to bring money supply and money demand into an equilibrium point When thecentral bank increases the supply of money, it causes the price level to rise Persistentgrowth in the quantity of money supplied leads to continuing inflation Inflation can be

so low that people do not pay any attention to it, as has been the case for the U.S overrecent decades It can be moderate, where people pay attention to inflation and changetheir economic behavior because of it Inflation can also be so high that it causessignificant problems in the working of the economy In order to have an accurateviewpoint on the fluctuation of inflation rate of Asian countries in the past decade, we

conducted research on the topic “Determinants of Inflation Rate: A Panel Analysis of

Asian Economies from 2011 to 2021”. 

Our research objective is to identify the factors that could have an impact on theinflation rate of all Asian nations between 2011 and 2021 and to clarify the dependency

of inflation rate on these factors Hence, the research question should be stated asfollows “What is the relationship between inflation rate and broad money growth, GDPdeflator, exchange rate, interest rate, wage and salaried workers, population growth,country income levels within Asian countries from 2011 to 2021?”

The object of our research is the inflation rate of 46 countries in Asia and sevenindicators of inflation rate, which are: Broad Money Growth, GDP Deflator, ExchangeRate, Interest Rate, Wage and Salaried Workers, Population Growth and CountryIncome Levels

The research scope includes content scope, time scope and spatial scope Thecontent scope is researching on factors affecting inflation rate in Asian countries Thetime scope of the data in this research is from 2011 to 2021 The spatial scope is thegeographical territory of 46 countries

This research consists of 3 main chapters as follows,

Chapter 1: Theoretical Framework,

Chapter 2: Methodology and Model Specification,

Chapter 3: Estimated Model and Statistical Inference

CHAPTER 1 THEORETICAL FRAMEWORK

1 Overview of Inflation

1.1 Definition of Inflation

Inflation is a sustained increase in the general price level of goods and services in

an economy over a period of time, or sustained reduction in the purchasing power perunit of money – a loss of real value in the medium of exchange and unit of accountwithin the economy

Galloping Inflation: inflation rate is from 10% to 99% per year This type willdestroy the economy and curb the engines of the economy

Hyperinflation: defined as inflation that exceeds 100% percent per year Costssuch as shoe-leather and menu costs are much worse with hyperinflation– and taxsystems are grossly distorted Eventually, when costs become too great withhyperinflation, the money loses its role as store of value, unit of account and medium

of exchange Bartering or using commodity money becomes prevalent

Expected inflation: depends on the expectation of individuals about governmentexpenditure in the future Its impact is small but helps to adjust production cost

Unexpected inflation: derives from exogenous shocks and unexpected factorsinside economy

1.3 Causes of Inflation

Demand-pull inflation is caused by continuing rises in aggregate demand (AD) inthe economy The increase in AD may be caused by either increases in the moneysupply or increases in government expenditure when the economy is close to fullemployment In general, demand-pull inflation is typically associated with a boomingeconomy

Figure 1.1 Demand-pull inflation

Source: (Barth & Bennett, 1975)

Cost-push inflation is associated with continuing rises in costs Rises in costs mayoriginate from a number of different sources such as wage increases and other highercosts of production

Figure 1.2 Cost-push inflation

Source: (Barth & Bennett, 1975)

2 Overview of Determinants of Inflation rate

2.1 Board money growth

Velocity and the quantity equation

M×V=P×YWhere:

M: Quantity of money

V: Velocity of money

P × Y: Dollar value of the economy’s output of goods and services 

It is called the quantity equation because it relates the quantity of money (M) tothe nominal value of output (P × Y) The quantity equation shows that an increase inthe quantity of money in an economy must be reflected in one of the other threevariables: The price level must rise, the quantity of output must rise, or the velocity ofmoney must fall In many cases, it turns out that the velocity of money is relativelystable

2.2 GDP Deflator

The GDP deflator is one measure that economists use to monitor the average level

of prices in the economy and thus the rate of inflation In Macroeconomics, it iscalculated as follow:

GDP deflator= Nominal GDP RealGDP ×100

Because nominal GDP and real GDP must be the same in the base year, the GDPdeflator for the base year always equals 100 The GDP deflator for subsequent yearsmeasures the change in nominal GDP from the base year that cannot be attributable to

2.4 Interest rate

The very concept of an interest rate necessarily involves comparing amounts ofmoney at different points in time To understand how much a person earns in a savingsaccount, we need to consider both the interest rate and the change in the prices Theinterest rate that measures the change in currency amounts is called the nominal

interest rate, and the interest rate corrected for inflation is called the real interest rate.The nominal interest rate, the real interest rate, and inflation are related approximately

of salaried labor force are an indicator of the “health” of the economy

This factor is not included in many previous studies; however, after running themodel, the authors found a relationship between this variable and inflation rate Thus,

we believe that this could be worth considering in future policies to control inflation

2.6 Population growth

Population growth can be defined as the increase in the number of people in agiven area The three main factors that affect population growth are fertility rate, lifeexpectancy, and net immigration

2.7 Countries Income Levels

The World Bank assigns the world’s economies to four income groups - low,lower-middle, upper-middle, and high income The classifications are based on theGNI per capita of the previous year GNI measures are expressed in United Statesdollars (USD), and are determined using conversion factors derived according to theAtlas method

The latest thresholds (2022 - 2023) for Atlas GNI per capita are as follows:

Table 1.1 WB countries classification in terms of income (2022-2023)

3 Literature review

A significant determinant of inflation that has been captured in several studies isboard money growth, or money supply M2 Sunil Kumar Chaudhary and Li Xiumin(2018) conducted OLS regression to clarify the impact of board money supply, realGDP and imported price on inflation in Nepal between 1975 and 2016 and the resultsshowed money supply M2 did have statistical significance and exert considerableinfluence on Nepal’s inflation rate In another study conducted by Fatukasi Bayo(2011) using OLS method with data of fiscal deficits, money supply, interest rate andexchange rate from 1981 to 2003 on Nigeria economy, the author concluded that allfour independent variables significantly and positively impacted inflation Research ofRakesh Kumar (2013) which employed Restricted Vector Autoregressive techniqueanalyzed the inflation dynamics in India and made an emphasis on the role of moneysupply on inflation by concluding “Money supply turned out to be the most importantvariable in explaining the variation in inflation overtime followed by import indexvariable” The study by Samuel A Laryea and Ussif Rashid Sumaila (2001) onTanzania in which they used an error correction model (ECM) to examine data fromQ1 1992 to Q4 1998 stated that inflation in Tanzania, either in the short run or the longrun, is influenced more by monetary factors and to a lesser extent by volatility inoutput or depreciation of the exchange rate

Interest rate and exchange rate are chosen as indicators for inflation rate in severalstudies A notable study conducted by Rana Ejaz Ali Khan and Abid Rashid Gill(2010) on the determinants of inflation in Pakistan within 1970-2007 chose OLSregression method to elaborate on the effect of eleven independent variables, includingexchange rate, annual interest rate and supply of money M2 on four dependantvariables implying inflation, which are Consumer Price Index (CPI), Wholesale PriceIndex (WPI), Sensitive Price Index (SPI) and GDP Deflator (GDPD) The findingsshowed that depreciation of exchange rate heightened the indices of CPI, WPI, SPI andGDP deflator and the increase in interest rate affects the CPI negatively; however, M2supply of money in the long-run did not affect CPI, which contradicts the conclusions

in the aforementioned studies

Sebastian Weiske (2019) estimated a medium-scale model of the US-economyand stated that declining population growth has lowered both the natural rate and

inflation by about 0.4 percentage points in recent decades, which means that lowerpopulation growth would release pressure on inflation In contrast, population growthhas been proven to be negatively correlated with inflation in the research body ofRuzima Martin and Veerachamy P (2015) in which data of government spending,import of goods and services, population growth, agriculture output and foreign directinvestment between 1970 and 2013 is processed using OLS regression model.

Those previous studies have examined the impact and relationship betweeninflation rate and some familiar macroeconomic variables such as GDP’s indices,money supply, import price, exchange rate and so on within some Asian and Africannations However, Asian countries are diverse in many levels, so there could be morefactors affecting the inflation rate in Asia That is the reason why the authors includeother variables which are theoretically proven to have an impact on the inflation rate toconduct empirical analysis in this research

4 Research hypotheses

After reviewing theoretical bases as well as previous researches, we hypothesizefor the research topic about factors affecting the change of inflation in Asian countriesduring the period of 2011 - 2021, in detail:

1) The board money growth and inflation rate have a positive/negativerelationship. 

2) GDP deflator and inflation rate have a positive relationship

3) Exchange rate and inflation rate have a positive relationship

4) Real interest rate and inflation rate have a negative relationship

5) Percentage of wage and salaried workers and inflation rate have a negativerelationship

6) Population growth rate and inflation rate have a positive relationship

CHAPTER 2 METHODOLOGY AND MODEL SPECIFICATION

1 Methodology

The authors conducted empirical research on the impact of 7 independent

variables (Broad money growth, GDP deflator, Official exchange rate, Real interest

rate, Wage and salaried workers, Population growth and level of Income) on inflation

in Asian countries After specifying the econometrics model, the authors collected

secondary panel data for 8 variables of 46 Asian countries between 2011 and 2021

from the World Bank, Asian Development Bank and the host countries’ Statistics

Department STATA software was used to formulate statistical description of

variables, test for any violations of assumptions including multicollinearity,

heteroskedasticity and autocorrelation and employ pooled OLS as the most appropriate

method to yield the regression result

2 Theoretical model specification

INF¿ is the dependent variable

BRM¿, GDPD¿,FX¿, IR¿,WAGE¿, PO¿ are independent variables

low¿,lowmid¿,upmid¿ are dummy variables

β0 is the intercept of the model

β1, β2,β3,β4, β5,β6, β7, β8, β9 are the population’s parameters (coefficients of

independent variables)

u i is the disturbance

2.2 Variables explanation

Table 2.1 Description of variables

Variable Name and Measured unit Expected Relationship

Dependent variableINFit Inflation rate (%)

Independent variablesBRMit Broad money growth (%) Positive/ Negative

FXit Official exchange rate (LCU/US$) Positive

WAGEit Wage and salaried workers (%) Negative

lowmid Lower-middle income

upmid Upper-middle income

Source: Compiled by the authors

3 Data statistical description

Using the command “sum INF BRM GDPD FX IR WAGE PO” in Stata, we got the result as follows: 

Table 2.2 Descriptive statistics results

POit 506 1.4951 1.8056 -6.8521 11.7940

Source: Compiled by the author

The INFit variable had 506 observations, with the mean of 5.18 and standard

deviation of 11.27, which shows that there was a gap in inflation rate in differentcountries The min value is -30.19 and max value is 150.0007, showing that therewere some unstable situations in the economy. 

The BRMit variable had 506 observations, with the mean of 11.95 and

standard deviation of 8.68 The difference between min value -9.09 and 58.91shows that money supply in countries widely varied

The GDPDit variable had 506 observations, with the mean of 218.02 and

standard deviation of 459.72, showing a big gap between nominal and real GDP.However, the difference between min value (70.09) and max value (5087.68)indicates that price changes increased a lot in this period

The FXit variable had 506 observations, with the mean of 1372.81 showing

that most objects of study had low value local currency The standard deviation3893.66 is large, as well as the huge gap between min and max values (0.27 -23208.37) indicates the huge difference of diverse countries in comparison to US$

The IRit variable had 506 observations, with the mean of 5.34 and standard

deviation of 11.07, a low level which moved demand from savings to investmentand consumption The gap between min and max values shows that the interval forinterest rate value was large

The WAGEit variable had 506 observations, with the mean of 62.77 showing

that not a large proportion of workers got paid basically Standard deviation 24.77,min-max value difference indicates the inequality in remuneration of workers invarious countries

The POit variable had 506 observations, with the mean of 1.49 and the

standard deviation of 1.8 showing a stable growth in population of these countries.However, min and max values have a big gap, which is not a good signal forcountries’ population at that time

Using command “cor INF BRM GDPD FX IR WAGE PO” in Stata, we got the result: