Microsoft Word KLTN docx MINISTRY OF EDUCATION AND TRAINING STATE BANK OF VIETNAM BANKING UNIVERSITY HO CHI MINH CITY TRAN DANG BAO TRAN IMPACT OF BASIC MACROECONOMIC FACTORS ON THE EXCHANGE RATE IN V[.]
INTRODUCTION
The necessity of the thesis
The exchange rate represents the amount of domestic currency needed to purchase one unit of foreign currency, facilitating the conversion necessary for international trade and fund transfers It enables price comparisons of goods across countries and is crucial for assessing competitiveness in the global market, impacting imports, exports, and private investment However, exchange rates are often volatile and can significantly influence the economy and daily life; for instance, when domestic currency appreciates, local goods may become costlier than foreign alternatives.
An imbalance in exchange rates can cause a country's currency to be overvalued or undervalued, impacting the government's ability to manage its macroeconomic objectives In today's open trade environment, exchange rates play a crucial role in influencing market prices and economic stability Notably, the U.S dollar remains the dominant currency globally, representing 80% of transactions in the foreign exchange market (Bloomberg).
Thus, in the study, people often use real exchange rate variables to measure competition in the field of international trade of a country (Korsu and Braima, 2011)
Understanding exchange rate volatility poses a significant challenge for policymakers and central banks Numerous global studies focus on the macroeconomic factors that influence the real exchange rate, aiming to improve the accuracy of exchange rate forecasts Key questions arise regarding which macroeconomic elements have the most substantial impact on exchange rates and whether the relationship between these factors is linear or non-linear (Mykhalova et al., 2013) By analyzing the effects of macroeconomic variables on the real exchange rate, policymakers and central banks can make informed decisions that align with economic needs.
Numerous studies have explored the influence of macroeconomic factors on exchange rates, yet researchers often select different variables for analysis While some focus on a single factor, others consider multiple macroeconomic variables, leading to varied results that depend on the specific country and the time period of the study.
In a globalized market economy, expanding trade relations is crucial, leading to increasingly complex issues regarding payment, valuation, and economic performance The exchange rate plays a vital role in international relations, particularly in Vietnam, where commercial banks must enhance their international payment and banking systems to support foreign trade growth There are diverse opinions on exchange rate management; some advocate for the State Bank of Vietnam to devalue the currency to boost export competitiveness, while others recommend maintaining fixed rates to prevent inflation and stabilize macroeconomic variables This highlights the sensitivity and complexity of exchange rate dynamics in the economy.
Vietnam has experienced significant economic growth over the past 20 years, establishing a solid foundation for the new century Between 1999 and 2000, the country achieved a remarkable growth rate, demonstrating its steady progress and resilience in the global economy.
Since 2005, the economic structure has undergone significant changes, leading to better mobilization of development resources and enhanced comparative advantages across various sectors and regions This transformation has contributed to an overall improvement in the economy's competitiveness.
Vietnam has actively engaged in international economic cooperation across key sectors, including trade, services, labor, and technology As a member of the Association of Southeast Asian Nations (ASEAN) and the World Trade Organization (WTO), the country has consistently expanded its bilateral economic relations and integrated into the global economy However, Vietnam faces significant challenges such as trade deficits, high inflation, and foreign debt, which have exerted considerable pressure on its exchange rate, particularly during the crisis of 2008-2009.
The global economy is gradually recovering post-crisis, although the anticipated double-dip recession has not materialized; ongoing crises in various regions complicate the path to pre-crisis growth levels The evolving complexities of the world economy, marked by contradictions, significantly affect the foreign exchange market, including Vietnam's In response, the State Bank of Vietnam (SBV) is committed to maintaining stable exchange rates within acceptable limits A thorough understanding of the macroeconomic factors influencing exchange rates is essential, enabling the SBV to effectively utilize monetary policy tools and implement necessary measures to stabilize both the exchange rate and the domestic economy.
I have chosen to focus my thesis on the "Impact of Basic Macroeconomic Factors on the Exchange Rate in Vietnam," analyzing data from 2000 to 2015 This timeframe offers the most recent and relevant data, enabling accurate forecasts and reliable scientific evidence to support the administration of exchange rate policy in Vietnam.
Research objectives
This thesis aims to elucidate the influence of key macroeconomic factors—namely GDP growth, interest rates, and inflation—on the real exchange rate in Vietnam, while also providing empirical evidence of their impacts and directions.
From the result, the author make recommendations for that impact to policy makers in managing the exchange rate.
Research question
Corresponding to the above mentioned research objective, the author develops two research questions as follows:
- Research question 1: Are macroeconomic factors affecting the exchange rate in Vietnam?
- Research question 2: If so, how does the macroeconomic factors affect the exchange rate in Vietnam?
The research subject and scope of the study
The subject of this dissertation is to study the impact of basic macro factors on the exchange rate in Vietnam including GDP growth, interest rate and inflation
This research utilizes data from the first quarter of 2000 to the fourth quarter of 2015, a timeframe during which Vietnam's statistics are notably comprehensive The data was sourced from the International Financial Statistics (IFS) of the International Monetary Fund (IMF).
Research method
In this dissertation, to answer the first question, author choose the correlation matrix to show the relationships among variables in the research model
The author employs a quantitative approach using the Vector Autoregression (VAR) model to analyze the influence of macroeconomic factors on Vietnam's exchange rate, covering the period from the first quarter of 2000 to the fourth quarter of 2015.
Research contribution
This dissertation contributes to providing empirical evidence on the basic macroeconomic factors effecting the exchange rate in Vietnam
The results of research may be used to use reference for macroeconomic policies of the economy.
Research structure
Apart from this chapter of introduction, the remainder of this dissertation is structured as follows:
Chapter 2 presents theories of exchange rates and selected macroeconomic variables in the research model Then, the author introduces the relationship of each macro factor to the exchange rate through theoretical frameworks and previous studies These overviews help the author shed light of the significance of this research and develop the research questions
Chapter 3 introduces the research model based on previous studies, reports the measurements of variables and sources of data, presents the hypotheses on the effects that the macroeconomic factors may have on the exchange rates, and the procedure that is employed to test whether the research model is a suitable model It also shows the direction of the impact of macroeconomic variables on the exchange rate in the period 2000-2015
Chapter 4 presents mainly the estimated results obtained from the regression analysis of the model as described in chapter 3 The results show that macro factors have a statistically significant impact on the exchange rate At the same time, the results also point to the impact of macroeconomic factors on exchange rates during the study period
Chapter 5 draws conclusions and presents recommendations to policy maker as well as the central bank It also discusses the limitations of the dissertation and recommends an agenda for possible future research.
Chapter conclusion
This chapter outlines the rationale for selecting the topic and the objective of analyzing the influence of key macroeconomic factors on Vietnam's exchange rate It also details the study's scope, methodology, and structure To establish a scientific foundation for the research, the author reviews relevant theoretical frameworks and related studies, aligning them with the defined objectives and methods of the investigation.
THEORETICAL BACKGROUND AND OVERVIEW OF
Theory of exchange rate
2.1.1 The concept of exchange rate
The first concept of exchange rate was defined by Karl Marx (1818 – 1883)
In his 1858 book "Capital," Karl Marx described the exchange rate as a historical economic category influenced by the production development stage of society and market maturity While Marx's concept is more theoretical, it reflects historical trends and fluctuations in exchange rates A more straightforward definition, widely accepted today, is that the exchange rate represents the price of one currency in terms of another For instance, if the exchange rate between the USD and VND is 1 USD to 21,100 VND, this indicates that one US dollar is equivalent to 21,100 Vietnamese dong.
In this dissertation, the chosen exchange rate is the rate the US Dollars againts Vietnam’currency (VND) and this is the common currency in Vietnam
The nominal exchange rate represents the price at which one currency can be exchanged for another, indicating how many units of domestic currency are needed to purchase a unit of foreign currency It reflects the current price of a currency without considering inflation effects An increase in the nominal exchange rate leads to the depreciation of the domestic currency, which can boost exports while limiting imports Conversely, a decline in the nominal exchange rate results in decreased export activity and increased imports However, the competitiveness of exports and imports is influenced not only by the nominal exchange rate but also by the actual exchange rate.
The real exchange rate measures the relative prices of goods between two countries when expressed in a single currency, reflecting the international competitiveness of a nation A higher real exchange rate indicates greater competitiveness for domestic goods, while a lower rate suggests diminished competitiveness.
The study of real exchange rates focuses on the trade relationships between countries, utilizing the bilateral real exchange rate (BRER) and the multilateral real exchange rate (MRER) The real exchange rate is derived from the trade interactions of a host country with its trading partners or through the average of multiple significant trading partners and competing nations When assessing the trade dynamics between two countries, the real exchange rate is identified as the BRER, whereas the comparison with multiple trading nations is referred to as the real effective exchange rate (REER).
2.1.2.2.1 Bilateral real exchnage rate (BRER)
The bilateral real exchange rate is the nominal exchange rate adjusted for inflation differences between two countries, reflecting the purchasing power of domestic currency against foreign currency It is calculated by comparing the prices of a basket of goods produced or consumed in one country with those in another, expressed in either domestic or foreign currency Additionally, the bilateral real exchange rate also considers trade relationships not only between two countries but also among countries and communities that share a common currency, such as the USD or EUR.
BRER is calculated by the following formula (equation 2.1):
BRER = Price of the foreign basket
Price of the domestic basket x nominal exchange rate (2.1)
At the point when BRER raised, the domestic currency is undervalued and when BRER dropped means the household moneyis highly valued
2.1.2.2.2 Real effective exchange rate (REER)
The real effective exchange rate (REER) measures the value of a currency in relation to its trading partners, reflecting changes in currency values across multiple currencies It is determined by the price correlation between one currency and others, providing insights into a country's competitiveness in international trade.
The nominal exchange rates (ei) represent the value of the i-th country's currency in relation to the domestic currency The trade weight (wi) reflects the significance of each country whose currency is included in the foreign currency basket Additionally, Pi denotes the price index of the i-th country, while P indicates the price index of the domestic country.
Macroeconomic factors
Numerous studies worldwide highlight the connection between exchange rates and macroeconomic factors Key elements such as inflation, gross domestic product (GDP), interest rates, and income are interrelated and significantly influence one another This research focuses on independent variables like economic growth, interest rates, and inflation to analyze their impact on the exchange rate, which is the primary macroeconomic factor under investigation.
Economic growth refers to the increase in a nation's income over a specific period, typically one year, and is essential for improving the quality of life for individuals It is a key objective for developing countries like Vietnam Understanding the relationship between economic growth and exchange rates is crucial, prompting an exploration of economic growth theories to analyze its impact on Vietnam's economy.
Economic growth refers to the increase in gross domestic product (GDP) or gross national product (GNP) over time, often measured by national average GDP per capita It relies on the accumulation of productive assets such as capital, labor, and land, along with effective investment in these assets Key factors influencing economic growth include savings and investment, government policies, institutional frameworks, political and economic stability, geographical features, natural resources, and the levels of health and education within a society.
The formula for GDP is as follows (equation 2.3):
(According to the spending method) With Y (GDP) is gross domestic product
Household final consumption expenditure (C) is determined using data from retail sales of goods and services, which is collected through surveys conducted by the General Statistics Office and commercial retail establishments, alongside information from the family living standard survey.
I is private investment which is calculated on the basic of sample data from non-state owned enterprises, individual business household and the balance sheet of agricultural products
G is the Government's regular expenditures that are calculated using the official current expenditure data available at the Ministry of Finance
NX, or net exports, represents the difference between a country's exports and imports, as detailed in its international payment balance sheet This metric serves as an expenditure indicator that highlights the nation's foreign economic relations.
Research indicates a significant relationship between real exchange rates and real GDP, as highlighted in Kia's 2013 study on open economies Additionally, various studies, including those by Kandil and Dincer (2008) and Wong (2013), utilize production as a key variable in examining exchange rates Consequently, this study focuses on GDP growth as the independent variable influencing exchange rates.
Inflation in a country leads to a depreciation of its domestic currency, as it affects the supply and demand for foreign currency This study focuses on inflation variables, drawing insights from existing theories and prior research on the topic.
Inflation refers to the rise in the general price level of goods and services over time, leading to a depreciation of the currency and a decrease in purchasing power When assessed in a global context, inflation signifies the devaluation of a country's currency relative to others.
The Consumer Price Index (CPI) is a key measure of inflation, frequently utilized by financial analysts and policymakers to assess exchange rate volatility and understand the inflationary trends within the economy.
Inflation refers to the sustained increase in the general price level of goods and services over time, as opposed to a one-time price shock Unlike a temporary rise in prices for a specific commodity or group of commodities, inflation signifies a continuous upward trend in overall prices within the economy (Mankiw, 2003).
We have a fomular for calculating inflation rate by CPI (equation 2.4):
The Consumer Price Index (CPI) is calculated using the formula CPI WYF x 100%, where CPI W represents the average price of a basket of goods and services in the current period, and CPI WYF reflects the average price in the original period This calculation helps in understanding inflation and price changes over time.
With 𝑞 A _ is quantity of product in the base year, 𝑝 A _ is price of product in the base year, 𝑝 A W is price of product in the current year
Inflation refers to the rise in prices, and the inflation index serves as a fundamental macroeconomic indicator In this dissertation, the author selects the Consumer Price Index (CPI) as the inflation variable to analyze its impact on the exchange rate.
Interest rates serve as a crucial tool for managing a nation's macroeconomy In today's globalized trade environment, fluctuations in a country's interest rates can have ripple effects beyond its borders, influencing international investments This phenomenon is supported by the theory of interest rate parity, which highlights the interconnectedness of interest rates and investment returns across countries.
𝑒 W + 𝜃 or 𝑖 = 𝑖 ∗ +%∆𝑒 e + 𝜃 (2.6) With, i is interest rate of domestic country, i* is interest rate of foreign country,
The rate of depreciation of a domestic currency (%∆𝑒) is influenced by the nation's risk (𝜃) An increase in a country's interest rates attracts capital flows seeking higher returns, affecting both the domestic and international capital landscape For instance, when the Federal Reserve raises interest rates, capital shifts to countries with higher rates of return, leading to increased demand for foreign currency and a depreciation of the domestic currency (Chau Van Thanh, 2016) Consequently, the author has focused on the theory of interest rates as a foundational aspect of this research.
An interest rate refers to the percentage charged or earned for the use of money, typically expressed annually It is determined by dividing the interest amount by the principal over a one-year period.
In this study, the variable interest rate used is the deposit interest rate.
The relationship between the exchange rate and macroeconmic factors and
2.3.1 The realtionship between the exchange rate and economic growth
Numerous studies have examined the macroeconomic factors influencing exchange rates, with researchers carefully selecting variables based on growth rate fluctuations Economic growth is frequently included as a key variable due to its significance in developed nations, particularly in Vietnam, where it has been a longstanding objective and a central focus in recent years Consequently, the author has chosen to investigate economic growth as a variable to analyze the effects of macroeconomic factors on exchange rates.
This article explores the relationship between exchange rates and economic growth, focusing on how economic growth influences exchange rates, supported by previous studies and relevant theoretical frameworks.
According to the Penn effect, two authors Balassa (1964) and Samualson
Research from 1964 indicates that wealthier countries tend to have higher price indexes compared to poorer nations, and that economic growth is more pronounced in countries engaged in commercial transactions The penny effect suggests that multilateral exchange rates generally mirror these trends Furthermore, when economic growth is concentrated in trade areas, both prices and the real exchange rate in those regions are likely to rise.
Previous studies have demonstrated a positive correlation between real exchange rates and economic growth, indicating that as economic growth accelerates, the real exchange rate tends to rise Researchers often assess this relationship by comparing the growth rate of production from one year to the next, highlighting the interconnectedness of exchange rates and economic performance.
To explore the relationship between exchange rates and economic growth, it is essential to examine relevant theories, particularly those from the Keynesian school, which provides a framework for calculating production using a specific formula (equation 2.7).
With: Y is the production of nation
The exchange rate significantly influences a country's economic output by impacting export and import activities Fluctuations in the exchange rate lead to changes in the prices of exports and imports, thereby affecting the competitiveness of exports in the global market.
In a floating exchange rate system, an increase in the exchange rate enhances export activities by making domestic goods and services cheaper compared to foreign alternatives, thereby boosting competitiveness Conversely, this rise in exchange rate leads to higher import costs, restricting import activities as importers face increased expenses for foreign currency, which can diminish their profits The resulting increase in exports and decrease in imports elevate the supply of foreign currency, causing the domestic currency's value to rise and the exchange rate to decrease This appreciation of the domestic currency further attracts investors, contributing to a continuous decline in exchange rates.
A decrease in exchange rates leads to an increase in the price of domestic goods in foreign currency, making it challenging for domestic exporters to compete in the global market Simultaneously, the lower price of imported goods compared to domestically produced items makes imports more competitive, resulting in a decline in total export turnover and an increase in imports This shift contributes to a deteriorating trade balance and a downturn in domestic production As exports decline, the supply of foreign currency decreases, causing the domestic currency to depreciate and the exchange rate to rise Consequently, foreign investors may withdraw their capital, further exacerbating the depreciation of the currency and increasing the exchange rate.
The relationship between exchange rates and economic growth is significant; an increase in economic growth typically leads to a rise in currency value and a decrease in exchange rates Conversely, a weaker growth rate results in a decline in the domestic currency's value, causing exchange rates to rise.
2.3.2 The relationship between interest rate and the exchange rate
In recent years, the expansion of bank networks has made banking essential for many individuals engaged in commercial transactions With the growing trend of Vietnamese people prioritizing savings, deposit interest rates have become a significant concern, particularly in light of Vietnam's economic policies This raises the question: how do interest rates influence exchange rates? This article aims to explore this relationship by providing a theoretical framework and referencing previous research studies, establishing interest rates as a key macroeconomic variable that affects exchange rates.
Uncovered Interest Rate Parity (UIP) theory and the Fisher Effect (IFE) illustrate the connection between interest rates and exchange rates, indicating that the spot exchange rate of one currency relative to another fluctuates based on the interest rate differentials between the two countries.
The interest rate parity suggests that the exchange rate difference between two nations will be made up by the difference between forward and spot rate of two currencies
The parity theory of interest rates is formed according to the one-price rule of the monetary market The interest rate parity is form based on 5 hypothesises:
- Capital is circulated among nations
- International currency business does not bear national risk
- The financial markets operate efficiently and compete perfectly
- The quality of securities is the same
The law of interest rate parity asserts that the forward exchange rate between two currencies, adjusted for any discount, is influenced by the difference in their respective interest rates.
The interest rate parity theory operates under the assumption that other factors remain constant, making its theoretical precision relative In reality, future exchange rates are influenced not only by interest rates but also by a variety of other factors.
The relationship between interest rate and the exchange rate is illustated by following formula:
- The difference between forward rate and spot rate shown through formula:
With: F is forward rate, S is spot rate, f is offset (discount)
- Rate of return when investing in foreign currency:
With 𝑟 q is rate of return, i* is interest rate on foreign currency deposit, f is the change in forward rate and spot rate
When there is a disparity in profitability between two currencies, investors will favor the currency with the higher interest rate until market equilibrium is achieved Once the market stabilizes, interest rate parity will be established This relationship between interest rates and exchange rates is illustrated by the formula (equation 2.8).
The relationship between domestic and foreign interest rates is crucial for investment decisions When the foreign interest rate (f) exceeds the domestic interest rate (i – i*), domestic investors are likely to seek opportunities abroad Conversely, if the foreign rate is lower than the domestic rate, foreign investors will prefer to invest in the domestic market When the foreign and domestic interest rates are equal, interest rate parity is achieved, leading to the conclusion of interest arbitrage.
2.3.3 The relationship between inflation and exchange rates
Empirical studies
The study by Maeso-Fernandez (2010) employs the BEER and PEER models proposed by Clark and MacDonald (1999, 2000) to analyze the determinants of the euro's real effective exchange rate The findings suggest that regions experiencing robust economic growth tend to have a positive correlation with increases in the real exchange rate.
The research conducted by F Ahmad in 2016 investigates the relationship between exchange rates, economic growth, and foreign direct investment (FDI) in emerging Asian economies, utilizing an ARDL model over the period from 1981 to 2013 The study employs a long-run estimation and variance decomposition approach to analyze the interactions among exchange rates (EXR), FDI, and GDP, providing fresh evidence on their interconnected dynamics.
𝜃 { 𝑇𝑅 AW + 𝜃 | 𝐵𝑇 AW + 𝑢 AW with FDI is foreign direct investment, GDP is economic growth, F is fianancial development measured by domestic credit to the private sector,
The study examines the relationship between physical capital (K), trade openness (TR), and the balance of trade (BT) with a focus on foreign direct investment (FDI) flows and their impact on a country's exchange rate Findings indicate that FDI positively influences the exchange rate, and economic growth significantly contributes to this effect at a 5% significance level Increased economic growth leads to higher exports and capital inflows, resulting in a current account surplus that strengthens the domestic currency This research, derived from developed economies, offers insights for policymakers in developing countries, highlighting that foreign investors consider exchange rates and economic growth when making investment decisions, as these factors affect expected returns and associated risks.
In 1991, Chinn conducted research on exchange rates, drawing from Meese and Rose's earlier study, focusing on quarterly exchange rates between the United States, Japan, and Germany The model incorporated independent variables such as total nominal money, real gross GNP, interest rates, inflation rates, and real net wealth, expressed as: s1 = 𝛼0 + 𝛼1(m- m*)t + 𝛼2(y-y*)t + 𝛼3(i-i*)t + 𝛼4(𝜋 − 𝜋)t +𝛼5(rw-rw*)t +𝜀t + seasonal dummies The findings indicated that when analyzing the USD/DM, USD/JPY, and DM/Yen exchange rates, both inflation and interest rate transformations exhibited a downward sloping relationship with the exchange rate.
De Boeck's (2000) research on the impact of macroeconomic news on exchange rates, utilizing data from developing countries between 1998 and 2000, employs a structural VAR approach The study reveals that unanticipated shocks in fundamental variables account for only a minor portion of unexpected changes in exchange rates Specifically, over forecast horizons of up to one year, variables such as output, inflation, and interest rates explain less than 5% of the total unanticipated variance in exchange rates.
In his 2003 study on interest rate and exchange rate dynamics in the Philippines, Bautista analyzes the relationship between these two financial indicators using DDC-GARCH methodology from 1988 to 2000 The findings reveal a positive correlation between exchange rates and interest rates, particularly during the economic crisis of 1997.
Causal relation between interest and exchange rates in the Asian currency crisis of Choi.I and Park.D (2008) in Indonesia, Korean, Malaysia, Thailand from
Between 1997 and 1998, two authors conducted an analysis using VAR models and concluded that maintaining high interest rates as a tightening monetary policy is ineffective for stabilizing exchange rates during a crisis They emphasized that sustaining elevated long-term interest rates incurs significant economic costs without achieving the desired stabilization of the exchange rate.
In their 2010 study, Joseph P Byrne and Jun Nagayasu examined the relationship between the real exchange rate and real interest rate in the USA and England from January 1973 to May 2005 Grounded in the theoretical model of Messe and Rogoff (1988) and assuming constant inflation, their research provides strong evidence of a significant equilibrium relationship between the real exchange rates and real interest rates of both countries.
The 2007 research by Ca’Zorzi, Hahn, and Sanchez on exchange rate pass-through in emerging markets utilized vector autoregressive (VAR) models across key countries in Asia, Latin America, and Central and Eastern Europe The findings reveal a significant correlation between inflation rates and exchange rates, highlighting the interconnectedness of these economic factors in emerging market economies.
In their 2013 study, Tran Ngoc Tho and Nguyen Huu Tuan examined Vietnam's Monetary Policy Transmission Mechanism using a vector autoregression (SVAR) model, focusing on the impact of monetary policy on economic activity and price control during the 1997 financial crisis The authors analyzed two distinct sample periods, with the first covering January 1998 to December 1998, allowing for a comparative assessment of the transmission mechanism across these timeframes.
The study analyzes the impact of macroeconomic factors, including US interest rates and oil prices, as well as domestic indicators like the consumer price index and VND interest rates, on Vietnam's inflation and exchange rate from 2006 to 2012 Findings reveal that the inflation response to exchange rate shocks remained consistent before and after Vietnam's WTO accession Prior to joining the WTO, a 0.13% devaluation of the VND led to a 0.006 - 0.007% increase in inflation, which later decreased to 0.002 - 0.004% Conversely, after joining the WTO, a 0.008% rise in the exchange rate resulted in a 0.003 - 0.004% inflation increase in subsequent periods.
In their 2007 study, "Exchange Rates and Fundamentals: A Non-Linear Relationship," Paul De Grauwe and Isabel Vansteenkiste explored the complex relationship between exchange rates and key economic factors such as inflation, money supply, and interest rates They categorized their research into two groups based on inflation levels—high and low—and utilized monthly data for analysis Their model, represented as ∆𝑒 W = 𝛼 •W + ∆𝑓𝑢𝑛𝑑 W 𝛽 •W + 𝜀 W, revealed that in high inflation countries, the influence of independent variables on exchange rates was more consistent compared to low inflation countries Additionally, the study indicated that the relationship between interest rates and exchange rates varies by country and is influenced by the duration of government bond yields.
In her 2014 analysis, Katarzyna Twarowska examines the factors influencing the fluctuations of the Polish Zloty against the Euro from 2000 to 2013 Key determinants identified include GDP growth, inflation, interest rates, the financial account balance, and the current account balance Twarowska presents a model to represent these relationships, expressed as Y = 𝛽0 + 𝛽1X1 + 𝛽2X2 + 𝛽3X3 + 𝛽4X4 + 𝛽5X5, highlighting the complex interplay of economic indicators that affect exchange rate dynamics.
The analysis utilizes a linear regression model with the OLS method to examine various economic factors impacting the exchange rate in Poland compared to the eurozone Key variables include the GDP growth rate difference (X1), inflation rate difference (X2), money market interest rate difference (X3), current account balance (X4), financial account balance (X5), and government deficit difference (X6) The findings indicate that the financial account balance and inflation are the most significant factors influencing the exchange rate, while interest rates positively affect it Additionally, government deficits contribute to greater fluctuations in the exchange rate, with other variables showing less importance.
The study by Muhammad Ismail and Abdul Qayyum Khan (2012) analyzes the factors influencing exchange rate variability in Pakistan from 1975 to 2010, focusing on inflation, growth rate, imports, and exports Utilizing a simple linear regression model with the least-squares regression method, the authors establish the relationship through the equation Y = 𝛼 + 𝛽1 𝐼𝑁𝐹 + 𝛽2 𝐺𝑅 + 𝛽3 𝑋 + 𝛽4 𝐼𝑀𝑃 + 𝜇, where Y represents the exchange rate The findings indicate that inflation significantly contributes to exchange rate volatility, leading to currency devaluation as it increases Economic growth is identified as the second most influential variable, while exports and imports have a lesser impact The authors conclude that Pakistan's fiscal and monetary policies are crucial in determining exchange rate fluctuations.
Table 2.1 Summary of prior studies
Study Scope and Method Study result
Exchange rate, economic growth and foreign direct investment in emerging
Asian economies: Fresh evidence from long run estimation and variance decomposition approach by Ahmad (2016)
Using ARDL model of developed countries in Asia during 1981-2013
The economic growth has positive effect to the exchange rate as well as the FDI flow
Chapter conclusion
This chapter explores the theories and concepts related to macroeconomic factors and their impact on exchange rates It also examines previous research to hypothesize the correlation between these variables The findings in Chapter 5 will determine the validity of these assumptions in the context of Vietnam.
RESEARCH METHODOLOGY
Research process
Figure 3.1 The process of research
Research data
The author analyzes quarterly data spanning from Q1 2000 to Q4 2015, providing a substantial timeframe for reliable estimates This extensive period captures the economic cycle, encompassing both pre-crisis and post-crisis data.
Selection and modeling to estimate
Check stationary of model with
Use the correlation matrix to examine the autocorrelation between variables
Estimate and verification the model by VAR method
Read the results and conclusion
Furthermore, data is collected from reliable sources The lecture collects data from the International Monetary Fund (IMF)
Table.3.1 Describe the variables in the model
Variable Symbol Decribe Expected influence Source
Real exchange rate of Vietnam
Growth of gross domestic product
Deposit interest rate of Vietnam
Consumer price index in Vietnam
Data collection
Data on the VND/USD exchange rate, interest rates, GDP growth rate, and consumer price index are sourced from the International Monetary Fund.
Data is collected quarterly (from Q1/2000 to Q4/2015) and included in excel for processing prior to put in eview 8.0.
Research model
This study aims to analyze the influence of macroeconomic factors on Vietnam's exchange rate, focusing on key elements such as inflation, economic growth, and interest rates Utilizing a vector autoregressive (VAR) model, the research will assess how these macroeconomic variables impact the exchange rate and explore the interrelationships among them.
The vector autoregressive (VAR) model, as defined by Brook (2008), is a hybrid systems regression model that combines elements of univariate time series models and simultaneous equations models Introduced by Sims (1980), the VAR model is recognized for its effectiveness in analyzing economic and financial time series, making it a valuable tool for forecasting future values, data description, policy analysis, and structural inference Its flexibility allows for the inclusion of multiple endogenous variables, resulting in a corresponding number of equations.
Vietnam, as an emerging country, provides a relevant context for examining previous research conducted in similar developing nations A notable study by Ahmad et al (2016) utilizes data from Asian developing countries, offering insights applicable to Vietnam's economic landscape Additionally, recent findings indicate that Vietnam is currently implementing the State Bank of Vietnam's floating rate policy (Truong Thi Hoa and Ngo Duc Tien, 2016), further aligning its financial practices with those of comparable nations.
Therefore, the author has the macroeconmic model as follows:
With: EX is exchange rates
The VAR model (3.1) is a time series model that incorporates interrelated variables, influencing both current and past values with specific time lags Consequently, the VAR model was chosen for the estimation and validation of the research model.
𝑌 FW = 𝑎 F_ + 𝑎 FF 𝑌 F WYF + 𝑎 Fw 𝑌 w WYF + 𝑎 Fx 𝑌 x WYF + 𝑎 Fy 𝑌 y WYF + 𝑒 FW
𝑌 wW = 𝑎 w_ + 𝑎 wF 𝑌 F WYF + 𝑎 ww 𝑌 w WYF + 𝑎 wx 𝑌 x WYF + 𝑎 wy 𝑌 y WYF + 𝑒 wW (3.2)
𝑌 xW = 𝑎 x_ + 𝑎 xF 𝑌 F WYF + 𝑎 xw 𝑌 w WYF + 𝑎 xx 𝑌 x WYF + 𝑎 xy 𝑌 y WYF + 𝑒 xW
𝑌 yW = 𝑎 y_ + 𝑎 yF 𝑌 F WYF + 𝑎 yw 𝑌 w WYF + 𝑎 yx 𝑌 x WYF + 𝑎 yy 𝑌 y WYF + 𝑒 yW or
𝑌 W = 𝐴 _ + 𝐴 F 𝑌 WYF + 𝐴 w 𝑌 WYw + 𝐴 x 𝑌 WYx + 𝐴 y 𝑌 WYy + 𝑒 W (3.3) Where: p is the latency of the model
𝑌 W … 𝑌 WYy is vector variables in the equation 𝑌 = (𝐸𝑅, 𝐺𝐷𝑃, 𝐶𝑃𝐼, 𝐼𝑅) Before being put for validation and estimation under the VAR model, GDP will be processed seasonally before being introduced into the model
Hypothesis
H1: Economic growth is positive correlated with exchange rate
Chapter 2's literature review illustrates the connection between exchange rates and economic growth, highlighting that as economic growth rises, the domestic demand for imported goods also increases, leading to a higher demand for foreign currency Consequently, an appreciation of the exchange rate boosts the value of foreign currency, and this relationship operates in reverse as well.
At the same time, previous studies show some evidences about the positive effect of economic growth on exchange rate, which is strongly supported by Ito
(1999), Maeso-Fernandez (2001), Crosby and Otto (2001), Bailu (2003), Hausmann
Thus, the author draws a hypothesis that economic growth is in the same direction as the exchange rate
H2: Interest rate is negative correlated with exchange rate
The relationship between interest rates and exchange rates is explained through interest rate parity, with previous research indicating that this correlation can be either positive or negative based on factors such as the timing of acquisition, the specific country analyzed, and the duration of the relationship When interest rates rise, it tends to encourage savings in the domestic currency, leading to increased demand for that currency, which subsequently raises its value and lowers the exchange rate Conversely, a decrease in interest rates can have the opposite effect This perspective is supported by studies from Chinn (1991), Martin (2015), Jonada (2015), and Ahmad (2016).
Thus, the author assumes interest rates in the opposite direction to the exchange rate
H3: Inflation is positive correlated with exchange rate
In previous chapter, the author introduces the relationship between inflation and exchange rate throgh the purchasing power parity (PPP) by Gustavav Casel
High inflation in a country typically leads to currency devaluation, as supported by previous studies conducted by researchers such as Shabana and Khan (2012), Tran Ngoc Tho and Nguyen Huu Tuan (2013), Magdalena and Katarzyna (2014), Ito (2007), and Taylor (2000).
Inflation has risen, leading to an overall increase in the economy's price levels As a result, domestic goods have become more expensive compared to foreign goods, which has decreased the demand for domestic products from foreign markets This decline in demand has reduced the supply of foreign currency, causing fluctuations in the foreign exchange rate; when the currency appreciates, it reflects these economic changes, and vice versa.
Therefore, the author assumes inflation in the same direction as the exchange rate.
Steps of data analysis and estimation
The dissertation uses Eview 8.0 to process data in the following steps:
- Step 1: Auguemented Dickey Fuller – ADF test
This section focuses on testing the stationarity of time series data using the Augmented Dickey-Fuller (ADF) method to prevent issues related to spurious regression in subsequent analyses The results of the ADF test can be influenced by the choice of lag length; therefore, the Akaike Information Criterion (AIC) proposed by Akaike in 1973 is utilized to determine the optimal lag for the ADF model.
H0 = 0: the time series is non – stationary
H1< 0: the time series is stationary
In ADF testing, the test value deviates from a normal distribution Dickey and Fuller (1981) state that the t-values of the model coefficients adhere to the t-statistic distribution, where the tau statistic is calculated by dividing the estimated coefficient by its standard error This calculation is performed during the ADF test using Eviews.
If the absolute value of the t-value exceeds that of the verification statistic, the null hypothesis H0 is rejected, indicating that the data sequence should be halted; conversely, if it does not, the null hypothesis is not rejected.
The author utilizes a correlation matrix to examine the relationships between variables, focusing on their correlation and linear associations The correlation coefficient (r) ranges from -1 to 1, indicating the strength and direction of these relationships.
After obtaining results from the correlation matrix, based on the above conditions, the author can make a statement that correlates the variables
- Step 3: Vector autoregressive – VAR model
After evaluating the stationary of the variables, the author proceeds to estimate the relationship between variables using the VAR model
To estimate the VAR model, it is essential to select the optimal lag length, followed by estimating the model based on this chosen delay Once the model is estimated, it is crucial to conduct verification of the results to ensure their reliability.
+ Verify the stability of the model with a condition that the typical solutions are outside the unit circle or the inverse solution in the circle unit
+ Verification of residual diagnosis: the author uses Lagrange – LM test, with the hypothesis:
H0: The residuals do not have a self-correlation to the lag
H1: The residuals are self-correlated to the lag Then, based on the prob value from the test result, the author accepts or refutes the hypothesis H0
The Causality test was first introduced by Granger (1969) and was put by Sims
(1972) into the VAR model Granger causality test is used to verify the direction of impact of pairs of variables
Table 3.2 The Granger causality test hypothesis
1 Y1t is not the cause of Y2t
If the value of Prob 10%), with the exception of the lag at 11, which is below 1% (𝛼 < 1%) This indicates that self-correlation is only present at the 11th lag in the VAR (5) model.
Granger causality test
To determine and test which macro factors affect the exchange rate between
2000 and 2015, the Granger method is used The test results are as follows:
Table 4.6 The result of Granger test
Excluded Chi-sq df p-value
According to the author's calculations using Eviews 8.0, Table 4.6 indicates that at a 10% significance level, the variables of GDP growth, CPI, and interest rate each have a p-value below 10% (𝛼