(Luận văn) the role of credit and monetary transmission in vietnam, a var approach

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..

UNIVERSITY OF ECONOMICS INSTITUTE OF SOCIAL STUDIES

HO CHI MINH CITY THE HAGUE VIETNAM THE NETHERLANDS

VIETNAM - NETHERLANDS PROGRAMME FOR M.A IN DEVELOPMENT ECONOMICS

THE ROLE OF CREDIT AND MONETARY TRANSMISSION IN VIETNAM: A VAR

APPROACH

BY

NGUYỄN LÊ THẢO NGUYÊN

MASTER OF ARTS IN DEVELOPMENT ECONOMICS

HO CHI MINH CITY, May 2012

UNIVERSITY OF ECONOMICS INSTITUTE OF SOCIAL STUDIES

HO CHI MINH CITY THE HAGUE VIETNAM THE NETHERLANDS

VIETNAM - NETHERLANDS PROGRAMME FOR M.A IN DEVELOPMENT ECONOMICS

THE ROLE OF CREDIT AND MONETARY TRANSMISSION IN VIETNAM: A VAR

APPROACH

A thesis submitted in partial fulfilment of the requirements for the degree of

MASTER OF ARTS IN DEVELOPMENT ECONOMICS

By

NGUYỄN LÊ THẢO NGUYÊN

Academic Supervisor:

Dr NGUYỄN VĂN NGÃI

HO CHI MINH CITY, May 2012

I sincerely thank Tutor- Mr Phung Thanh Binh who provided me materials, also economic techniques relevant to my thesis I am grateful to all lecturers and tutors of Vietnam-Netherlands Master Program in Development Economic, who have made invaluable contributions

I wish my express my special thanks to my friends Nguyen Van Dung, Le Anh Khang,

Vo Thi Ngoc Trinh They have spent a lot of time and effort in helping me during my writing

Last but not least, I thankful to my lover, parents and brother who were always beside

me and gave me spiritual support

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 In this study, I investigate the role of credit channel in monetary transmission mechanism in the case of Vietnam Two different specifications of loan markets are conducted: classical market (without domestic credit) and augmented market (with domestic credit) to look for the evidences of the role of credit Vector autoregression model which focuses on the reduced form will be employed as main econometric techniques in this thesis The empirical results support that credit channel plays important role in monetary transmission in Vietnam case The correlation between lending channel and monetary policy is somewhat weak The policy implication that credit sector should be carefully controlled when implements new monetary policy

Key words: domestic credit, credit channel, monetary policy transmission, VAR

model

Table 4.4: Optimal lap-Classical market Table 4.5: Optimal lap- Augmented market Table 4.6: VAR Regression Statistic- Classical market Table 4.7: VAR Regression Statistic- Augmented market Table 4.8: Variance Decompositions for vector autoregression for Classical and Augmented Market

LIST OF FIGURES

Figure 3.1: Analytical Framework Figure 4.1: The impulse response functions for classical market Figure 4.2: The impulse response functions for augmented market

ADF: Augmented Dickey Fuller PP: Philips-Perron

LR: sequential modified LR test statistic FPE: Final prediction error

AIC: Akaike information criterion SC: Schawarz information criterion HQ: Hannan-Quinn information criterion

U.S: United States

TABLE OF CONTENTS

CHAPTER 1: INTRODUCTION 9

1.1 RELEVANCE AND BACKGROUND OF STUDY 9

1.2 PROBLEM STATEMENT 10

1.4.RESEARCH QUESTION 11

1.6 STRUCTURE OF THESIS 12

CHAPTER 2: LITERATURE REVIEW 14

2.1 CREDIT CHANNEL THEORY 14

2.2 MONETARY POLICY FRAMEWORK OF VIETNAM 16

2.2.1 LEGAL FRAMEWORK 16

2.2.2 MONETARY POLICY STRATEGY AND INSTRUMENTS 17

2.2.3 VIETNAM’S FINANCIAL MARKET OVERVIEW 19

2.3 EMPIRICAL LITERATURE 21

3.1 ANALYTICAL FRAMEWORK 27

3.2 MODEL SPECIFICATION 28

3.3 DATA SOURCES 30

3.4 STEPS OF ESTIMATION 32

CHAPTER 4: FINDING AND DISCUSSION 34

4.1 DESCRIPTIVE STATISTIC 34

4.2 UNIT ROOT TESTS 35

4.3 VAR REGRESSION STATISTICS FOR CLASSICAL AND AUGMENTED MARKET 37

4.4 IMPULSE RESPONES AND VARIANCE DECOMPOSITIONS 40

4.5 RESULTS COMPARISON 47

CHAPTER 5: CONCLUSION AND POLICY IMPLICATION 49

5.1 CONCLUSIONS 49

5.2 POLICY IMPLICATION 50

5.3 LIMITATION AND FURTHER STUDIES 53

5.3.1 LIMITATION 53

5.3.2 FURTHER STUDIES 53

REFERENCES 55

APPENDIX 58

CHAPTER 1: INTRODUCTION

This chapter will present how important of this study is, its objectives and research questions In addition, a brief of methodology is also mentioned in this chapter Finally, the scope and structure of thesis are deal with in this part

1.1 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)

1.2 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

1.3 RESEARCH 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

- 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?

1.5 METHODOLOGY

To carry out above objectives, this study uses quarterly data from 1996:Q1 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 (VAR) 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 of t-test and F-test in firstly Next, optimal lag lengths for VAR 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 VAR 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

1.6 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

CHAPTER 2: LITERATURE REVIEW

In this part will be described theories applied in thesis as briefly Next, the framework

of monetary policy in Vietnam is presented in this part Besides that, some remarkable empirical studies regarding to the role of credit in monetary transmission in other countries, also in Vietnam will be introduced

2.1 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 turn decrease leading to financing investment and consumption

2.2 MONETARY POLICY FRAMEWORK OF VIETNAM 2.2.1 LEGAL FRAMEWORK

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 of the 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 of SBV’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 Board1 (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

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 turn, 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, 2010)

Open Market Operations (OMOs)

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 of 7.5% 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 of 2010 (SBV, 2010)

Discount Policy

Besides changing reserved requirement, a refinancing and a discount facility are another tool of SBV’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)

2.2.3 VIETNAM’S FINANCIAL MARKET OVERVIEW

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

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 Credit to

Economy (tril.) 155 191 240 318 443 598 734 1,100 1,404 2,040 2,690

Credit to Economy (growth rate) 23% 25% 32% 39% 35% 23% 50% 28% 45% 32%

GDP (tril.)

442 481 536 613 715 839 974 1,144 1,485 1,658 1,981

Credit to Economy (%

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 of SBV

Vietnam is targeting credit growth at 15-17 percent this year and a 14-16 percent increase in money supply (Reuters News, 2012) Monetary policy will be used by Central Bank to meet a credit growth Nguyen Van Binh, the Governor of SBV, quoted

in December lending growth could stay below 15 percent SBV continues to focus on development of agriculture and rural sectors, production of goods for export, auxiliary industries and to support small and medium-sized enterprises (Baomoi News, 2011)

Agribank, Vietnam’s top lender by assets, is still chosen in fund disbursement, account for 75-89 percent of its loans for agriculture and rural development Further, central bank has allocated various annual credit growth targets for domestic banks For ranking between zero and 17 percent, SBV divided banks into four groups, which have maximum loan growth rate of 17 percent, 15 percent, 8 percent and zero percent respectively (Reuters New, 2012)

2.3 EMPIRICAL LITERATURE

In recent years, many empirical studies related to the role of credit in monetary policy transmission have been done At beginning, Bernanke 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 Bernanke 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, M1, 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, Bernarke 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

2 Bernanke and Blinder had treated monetary transmission mechanism was “black box” in journal

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 of U.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 view3 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 (VAR) 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

three main variables of Thailand economy (real output, the CPI, and 14-day repurchase rate) through 1993-Q1 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:Q1 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 (SVAR) 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 SVAR 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 VAR 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, Catão and Pagan (2010) employed an expectation-augmented SVAR 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 (VAR) 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, VAR 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

3.1 ANALYTICAL FRAMEWORK

Rely on theory and empirical studies, an analytical framework is conducted below

Figure 3.1: Analytical Framework

Monetary policy

Classical Market

Augmented Market

VAR model

Empirical Results

Interest rate

Exchange rate

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 VAR 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

3.2 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 policy transmission in the case of Vietnam

Following the result of Stock and Watson (2001), VARs comes in with three varieties:

reduced form, recursive and structural The thesis uses VAR 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 of VAR model can be derived as:

Y t = C +  (L)Y t-1 +t

Where: t = 1, ,T denotes time;

Yt is an m-dimensional vector of endogenous variables

C denotes a vector of constants;

 (L) denotes vector polynomial of lag operator with optimal lag order;

t is assumed to be vector white noise residual

The error term (t) 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:Q1 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