Determinants of inflation in vietnam during the post liberalization period (1986 2015) m a

The period 1976–1986, Vietnam’s economy dominated by small-scale production, outdated technology, low labor productivity, high unemployment rate; then government applied the concentrated

DETERMINANTS OF INFLATION IN VIETNAM DURING THE POST LIBERALIZATION PERIOD (1986-2015)

By Nguyen Thi Nhu Quynh

A dissertation submitted to the University of Colombo in partial fulfillment

of requirement of the degree of Masters in Economics 2015

Department of Economics Faculty of Arts University of Colombo April, 2017

DECLARATION

I, Nguyen Thi Nhu Quynh, declare that the Masters in Economics dissertation entitled

“DETERMINANTS OF INFLATION IN VIETNAM DURING THE POST LIBERALIZATION PERIOD (1986 – 2015)” is not less than 30,000 words in length and

it carries exclusive of tables, figures, appendices, references, footnotes and appendixes This dissertation contains no material that has been submitted previously, in whole or in part, for the award of any other academic degree or diploma Except where otherwise indicated, this dissertation is my own work

Dr UP.P Serasinghe

Senior Lecturer, Department of Economics

University of Colombo

DEDICATION

To my family who gives me the warmest loving in my life!

ACKNOWNLEDGMENTS

First of all, I would like to express my deep gratitude to my supervisor Dr Prasad Serasinghe whose guidance and encouragement to my efforts are vital to the research His advises and invaluable comments from time to time to make the research fulfilled

And the big thanks to Dr Priyanga Dunusinghe whose guidance in statistics method to complete my research successfully He provided more encouragement, ideas, and opportunities than I ever expect

My sincere thanks go to the Government of Sri Lanka and Government of Vietnam who granted me scholarship to attend at University of Colombo to complete Master degree in Economics

I would like to express my sincere thanks to my friends, relatives and colleagues whose faithful co-operation and moral supports extended to me to complete

ABSTRACT

One of the most important problems of any economy is the inflation problem; understand the nature of inflation in the economy to help the country maintain stability and sustainable development Vietnam has experienced hyperinflation period immediately after liberalization (1986) and have experience in the control of inflation Since the end of year 2007, inflation in Vietnam was in a buoyant, although inflation is not so serious in this time period, but it is necessary to study the factors decisions of Vietnam inflation during the post liberalization period to understand what was happening in the economy and new assumptions in the next stage

This research studies the determination of inflation in Vietnam during the post liberalization period 1986-2015 Conventional notions suggest that money supply give rise to inflation, which monetary policy on its own is powerless to prevent Understanding the nature of inflation in the economy helps for stabilization and sustainable development By looking at the impact of the determinants of inflation, this research raises a concern about the ability of the inevitable upward trend of inflation in the economy of Vietnam; the research examines the issue in the case of Vietnam using Johansen co-integration analysis The empirical results suggest that in the long-run inflation is related to money supply, and money supply has impact on inflation Hence, the government should apply practical solutions to curb inflation down to a figure as desired

Keywords: Inflation, determinants of inflation, money supply, co-integration, Vietnam

MAIN CONTENTS

Page

DECLARATION i

DEDICATION ii

ACKNOWNLEDGMENTS iii

ABSTRACT iv

LIST OF TABLES viii

LIST OF FIGURES ix

ABBREVIATIONS x

CHAPTER ONE INTRODUCTION 1.1 Background 1

1.2 Research Problem 3

1.2.1 Problem Statement 3

1.2.2 Problem Justification 4

1.3 Research Questions 5

1.4 Research Objectives 5

1.4.1 General Objective 5

1.4.2 Specific Objectives 5

1.5 Limitations 6

1.6 Structure Of The Thesis 6

CHAPTER TWO THEORETICAL BACKGROUND AND LITERATURE REVIEW 2.1 Introduction 8

2.2 Theoretical Background 8

2.2.1 Demand-pull Inflation 9

2.2.2 Cost-push Inflation 11

2.2.3 Market Power Theory of Inflation 12

2.2.4 Okun’s Law 13

2.2.5 Phillips Curve 14

2.3 The Relationship between Inflation and Other Factors 16

2.3.1 Money Supply and Inflation 16

2.3.2 Inflation and Exchange Rates 17

2.3.3 Interest Rates and Inflation 17

2.3.4 Inflation and Government Spending 18

2.4 Empirical Evidence 19

2.4.1 Evidence from Vietnam 19

2.4.2 Evidence from other countries 22

2.5 Summary 24

CHAPTER THREE ECONOMIC PERFORMANCE IN VIETNAM DURING 1986 - 2015 3.1 Introduction 26

3.2 Trends in Inflation 26

3.3 Trends in Public Expenditure 28

3.4 Trends in Exchange Rate 31

3.5 Trends in Balance of Trade 31

3.6 Inflation in Vietnam during The Post Liberalization Period 34

3.6.1 Inflation during 1986 – 1989 34

3.6.2 Inflation during 1990 – 2007 39

3.6.3 Inflation during 2008 – 2015 44

3.7 Relationship between Unemployment and Inflation 49

3.8 Summary 51

CHAPTER FOUR RESEARCH METHODOLOGY 4.1 Introduction 52

4.2 Data Collection and Sources 52

4.3 Data Analysis Method 52

4.3.1 Description Data Analysis 52

4.3.2 Regression Analysis 53

4.3.3 Specify the Regression Framework 54

4.3.4 Data and Data Transformation 56

4.4 Summary 57

CHAPTER FIVE RESULTS AND DISCUSSION 5.1 Introduction 58

5.2 Trends in Inflation 58

5.3 Trend in Money Supply and GDP 61

5.3.1 Money Supply 61

5.3.2 GDP 64

5.4 Estimation and Interpretation of Results 67

5.5 Discussion 73

CHAPTER SIX CONCLUSION 6.1 Introduction 75

6.2 Conclusion 75

6.2 Policy Implication 77

APPENDIX 80

REFERENCES 92

LIST OF TABLES

Table 3.3.1 Selected Indicators: Government Expenditure (1996 – 2007) (unit %) 29

Table 3.3.2 ICOR calculated at constant price in 1994 30

Table 3.5 Export and Import index (Previous Year = 100) 32

Table 3.6.1 GDP and Inflation in first quarter period 2007 – 2007 (unit %) 36

Table 3.6.2 Vietnam’s inflation in comparison to developing Asia countries in ASEAN, the period 1990 – 2007 42

Table 3.6.3 CPI during 2011 – 2015 in Vietnam 46

Table 5.4.1 Augmented Dickey–Fuller (ADF) Unit Root Tests 67

Table 5.4.2 Augmented Dickey–Fuller (ADF) Unit Root Tests on Residual 68

Table 5.4.3 Co-integration Test Based on Johansen’s Maximum Likelihood 69

Table 5.4.4 Vector Error Correction Estimates 71

Table 5.4.5 Pairwise Granger Causality Tests 72

LIST OF FIGURES

Figure 3.6.1 Inflation and GDP in Vietnam during the period 1986 – 1989 38

Figure 3.6.2 Inflation and GDP in Vietnam during the period 1990 – 2007 41

Figure 3.6.3 Inflation and GDP in Vietnam during the period 2008 – 2015 45

Figure 3.7 Relationship between unemployment rate and inflation rate (2000 – 2014) (unit %) 50

Figure 5.2 Trend of Inflation in Vietnam during(1986 –2015) (unit %) 59

Figure 5.3.1 Money supply M2 (USD billion) 63

Figure 5.3.2 GDP (USD billion) 66

ABBREVIATIONS

ADB the Asian Development Bank

AFTA ASEAN Free Trade Area

ASEAN Association of Southeast Asian Nations

BTA Bilateral Trade Agreement

ICOR Incremental Capital - Output Ratio

GDP Gross Domestic Product

GNP Gross National Product

USD United States dollar

WB World Bank

WTO World Trade Organization

The period 1976–1986, Vietnam’s economy dominated by small-scale production, outdated technology, low labor productivity, high unemployment rate; then government applied the concentrated subsidized economy model, reform agricultural sector, heavy industry sector was selected as the main factor to growth and developed the economy The State established on international economics relations, encouraged in established the private businesses, foreign investment and foreign-owned enterprises; economy grew at the rate of greater than 7%, poverty was halved May 5th, 1978, unified currency in the country (the currency is Vietnam dong–VND), made favorable conditions for the exchanges, payment and control the money amount in circulation (World Bank, 2015)

At the time, inflation rate increase from 25.2% (1980) to 91.6 % (1985) with the average inflation in this period was 66% (World Bank, 2015)

From the year 1986, Vietnam started liberalized, transitional economic from the concentrated planned subsidized economy to operate in accordance market economy During 1986–1989, economic growth was only 0.4% per year, the balance of payment was imbalance seriously, domestic production could only meet 80–90% domestic used, foreign debt increased, budget deficit lead to Government printed money then it did appear hyper-inflation in 1986 with the CPI recording 453.5% increase (World Bank, 2015), the average rate of inflation rate in this period was 321.025% after that inflation suddenly dropped 95.8% in 1989, this might consider as the initial success of the innovative programs, causing a new stage of Vietnam’s economy The unemployment rate in Vietnam has distinctive characteristics, as the economy changes to the market economy since 1986, the unemployment rate rose, while prices rose In 1989, the unemployment rate up to 12.7% of total employment cause of lower production scale, rapid population growth, GDP per capita was only USD 86 (World Bank, 2015)

The period 1990–1995, compare with all period above annual inflation rate in this time was low with an average rate at 31.7% while GDP grew at average rate of 7.5% per year

In the time 1993–1997, Vietnam curbed inflation and rapid growth Then, economics slowdown in two years 1998 and 1999; early 2000s, economy continues to grow rapidly Inflation, together with unemployment rate had downtrend from 10.6% in 1993 to 5.88%

in 1996 and 6.01% in 1997; an average rate was 7.1% in this period In 1995, the number

of unemployed people was 2.6 million (at the ages 15–30), 85% of the total From 1998, unemployment rose sharply in urban than in other regions (World Bank, 2015)

The 1990s and early 2000, Vietnam was active in economic integration (joining ASEAN

in 1995, APEC in 1998, WTO in 2006), GDP per capita reached USD 396 (Laos USD

328, Cambodia USD 283) From 1996–2007 was an ideal span of Vietnam’s economy Annual inflation rate was fairly low; it was well controlled fewer than 9% with an average rate at 4.8% The high growth due to positive effects from signing of trade made unemployment rate decreased from 6.74% in 1999 to 6.42% in 2000 and 6.28% in 2001, inflation fell sharply during this period as well as the effectiveness of the exchange rate adjustment since 1997 The financial crisis in Asia (1997) made the value of the Vietnam dong was devaluation, capital investment in Vietnam fell sharply; Government did twice

adjusted the exchange rate from VND 11.113 per USD in 1996 to VND 13.908 per USD

in 1998 The increase in exchange rate has contributed to reducing the trade deficit 20.3%

in 1997 to 17.6% in 1998 (World Bank, 2015)

However, inflation has followed an upward trend from the year 2006 and accelerated from half late of year 2007, inflation shot up to 23.1% in May of 2008, then maintained under 9% some years later (in 2015, just 6.6%) Vietnam’s economy is considered to be less efficient operations in recent years, economic development spreading width, effective of investment was not high that was the main reason for high inflation in 2008–

2011 Declining economic growth from 8.48% in 2007 to 6.23% in 2008 and 5.2% in

2009, whereby the unemployment rate also tends to increase 0.1% per year (World Bank, 2015)

1.2.1 Problem Statement

In the past years since Vietnam’s economic liberalization often suffered high inflation makes the achievements of economic growth cannot get to the laborers, due to nominal income growth did not keep up chase the increase of the market price From the late 2007

to early 2008, Vietnam’s economy is facing a very difficult situation: inflation risk I return, but we look forward to increase speed to achieve the target of 2020 and develop objectives in the future beyond

In particular, in 2008 inflation rose very high at over 23% forced the government to make the system eight measures to curb inflation and achieved certain results when inflation in

2009 and 2010 tend reduced However, inflation has increased again in 2011 up to 18.1%, although the Government had launched a comprehensive system of measures to control inflation at the beginning of 2011 The problem is why inflation in Vietnam is rising? The solution is suggested to curb inflation down to a figure as desired by the Government? (World Bank, 2015)

1.2.2 Problem Justification

The impact of international economic integration for macroeconomic stability in Vietnam for four years after joining the World Trade Organization is complicated In two years 2006–2007, Vietnam has maintained a high growth rate, especially in 2007, GDP growth reached 8.5%, 0.3% higher than 2006 and the highest level the most in eleven years However since 2008, due to the effects of the world economic context and the intrinsic difficulties of the economy, especially the high inflation in 2008 and the financial crisis and economic downturn world since late 2008, economic growth has slowed, GDP growth reached 6.2% in 2008, reaching 3.3% in 2009 In 2010, the economy has tended

to recover and to grow around 4%, higher than the previous year’s growth rate, but still lower than the growth in the period 2000–2007 (Statistical Yearbook 2015)

The first half of2008, inflation is the number one problem of economic policy Growth rate of consumer price index rising continuously since February peaked in May (up 3.19%) Convergence caused by demand-pull inflation, cost-push inflation and monetary excess The government had to issue corrective measures for each cause

Inflation and imported cost-push inflation, a weaker dollar this period as world commodity prices, especially since the country exports to Vietnam increased relatively The trade deficit became a serious problem Trade deficit of May 2008 on USD 14.4 billion, higher than the 2007 deficit (trade deficit in 2007 was USD 14.12 billion, with 29% of exports) The increase in the CPI in May and peaked in the year (Statistical Yearbook 2015)

Demand-pull inflation: Total investment of the whole society in 2007 is about VND 493.6 trillion, accounting for 43% of GDP with a capital of foreign direct investment was USD 21.3 billion approved and implemented capital of USD 6.4 billion, 77% higher than

in 2006 The total state budget expenditures reached VND 399.3 trillion, exceeding by 12% compared to the annual estimates, State budget deficit of VND 56.5 trillion, equal to 5% of GDP Trade deficit was USD 14.12 billion, with 29% of total exports, increased by 2.5 times compared to 2006 Growth momentum which causes the currency in the

economy increased, High energy absorption than the economy, increasing inflationary pressures (Statistical Yearbook 2015)

Inflation caused by excessive money growth rate of the total means of payment and credit balance in 2007 doubled compared to the growth rate of 2006 As of 31st December,

2007, the total means of payment increased by 46.7 % compared to 31st December, 2006 Total loans in the economy increased by 58% in 2007 compared to 2006 The causes of the credit growth rate is due to mutations of the total net flows of foreign currency into the economy in 2007 is estimated to reach USD 22 billion, equivalent to 30% of GDP To maintain the USD, the State Bank has foreign exchange reserves increased from USD 11.5 billion (2006) to USD 21.6 billion (2007) and push a large amount of domestic currency market (Statistical Yearbook 2015)

The fact poses the need to have comprehensive research, insight into the causes of inflation and macroeconomic instability So the current research focuses the following specific three questions:

1 What is determinant of inflation in Vietnam during the post liberalization period (1986–2015)?

2 How does the money supply impact on inflation during the post liberalization period?

3 What is the causal relationship between inflation and money supply in the long-term?

2 To examine the causes of inflation in Vietnam during the post liberalization period

3 To study the measure to the control inflation in Vietnam in the short-term and term, while maintaining stability and economic growth in the coming years

Cause the number of limited observations; it is difficult to divide the sample into the stage The paper focuses on long-term behavior of inflation, so the short-term relationships will not be mentioned much The inflation rate was studied in this paper is the CPI inflation rate due to limited data problems

The research studies the period 1986–2015, selected research phase aims to get the full data needed for analysis The 1986 period is considered to be the beginning of a new page in the economic history of Vietnam: good and stable performance

The research includes six chapters

Chapter One is designed to introduce Vietnam’s economy before and over period 1986–

2015 (the post liberalization period in Vietnam) to give background, justification for the problem The problems and aims of the work are presented; limitations of the research are mentioned and the last section of this chapter outlines the structure of the thesis

Chapter Two gives summary of the current understanding of inflation The literature relevant to this work is presented and theoretical background; Empirical evidence in the studies of inflation in Vietnam and other countries are also covered in this chapter

Chapter Three presents the main factors are leading to inflation in Vietnam’s economy, such as Commodity price rising, Public expenditure, Exchange rate, Balance of trade, relationship between unemployment and inflation are covered This Chapter also mention about economic performance in Vietnam during 1986–2015 with the findings and explaining of why inflation in Vietnam has been happened for such long period

Through this, Chapter Four is about introduce the research methodology; explaining about the sources of data which is collected to analysis in the chapter Five, and the methods is used to analyze the data are also presented in Chapter Four

Chapter Five focuses the trend of inflation, trends in money supply and GDP which are combining to inflation in the economy Thereby verifying the impact of money supply and GDP on inflation in Vietnam by using the regression model to measure, calculate data for the convincing results

The conclusion and recommendations for future work are mentioned in Chapter Six

In economics, inflation is an increase in the average price level of goods and services in a nation over time Kemmerer (1888) defines inflation is “too much currency in relation to the physical volume of business being done” And Crowther (1941) says that inflation is

“a state in which the value of money is falling: i.e prices are rising” In economics, inflation is the increase over time in the general price level of the economy In an economy, inflation is the loss of market value or purchasing power of money fell When compared with other economies, the inflation is the devaluation of a currency versus other currencies In view of the classical economists, inflation is a mass flow value (money) excessive prices lead to partial loss of signal value for its nominal face value Economists said that the volume of money in circulation pump larger volumes needed money; Manifestation of this phenomenon is the paper currency depreciated against the goods, with gold, with foreign currency People do not want to keep the money and do not want to bring the money to deposit at banks that moved into direct investments or

withdraw money to purchase real estate, hoarding gold As a result the banking system a serious cash shortage, the demand for bank loans is denied because no resources to respond, the seller, the price increase at a rate greater than the inflation rate According to the classical economists, the inflation under capitalism is entirely subjective volitional exploiting classes’ right through manipulation of the system caused banks

In view of the modern economists, the inflation is a chronic disease of any economy monetary goods It has no class nature that only economic nature It features a permanent,

if not regularly control, no anti-inflation measures permanent, uniform and effective, then inflation can occur in any commodity economy with any mode society Economists suggest that expression of inflation is: when the general level of prices of goods and production costs while increasing a common way for a long enough period of time to identify trends So if prices rose in some anonymous group or seasonal spikes, they must eliminate those factors in a way calculated core inflation indicators

Inflation might be caused by other different factors; each factor can be in variety of different theories The theatrical explanation on inflation based on two causes of inflation; there are demand-pull and cost-push (Gordon, 1988)

2.2.1 Demand-pull Inflation: Increase in Demand

Demand-pull inflation is essentially due to the imbalance of supply and demand of goods and services in which players have the ability to pay greater than the supply of goods or the rate of increase in total payment means greater speed increased levels of production, resulting in the market, scarcity of goods relative to the amount due at the same time both groups of goods and money reasons Backward production, underdevelopment, low labor productivity, production capacity has almost reached the potential value of output in current conditions but cash levels are still pumping out too much absorbed through the valve: large budget expenditures compared to revenues, margins too wide open of the credit limit, required reserve ratio is too small, the refinancing rate is too low, capital market system is lacking and imperfections in foreign currency when entering many as forming the “synergy” stimulus higher than supply etc (Gordon, 1988)

Inflation arises when demand for goods and services in an exceed supply of the goods and services This is achieved when government increases its public expenditure – thereby increasing the purchasing power of the households Therefore, money income of reduction increases and so does that of expenditure on consumption of goods In such a case, excess demand leads to inflation If government reduces direct taxation people need

to pay fewer amounts as tax This offers more disposable income in the hands of the people This in turn may be used to buy more goods and services for private consumption

as well as for capital goods

Exports create shortage of the goods for domestic consumption when more goods are exported to foreign countries less is available for home consumption Thus, increase in export reduces of the goods available for domestic consumption giving rise to inflation represents

Keynesian argument

According to Keynes, unemployment is a destabilizing factor for the economy, so he advocated encouraging all activities can raise aggregate demand and employment volume To reduce unemployment he advocated putting money into circulation; perform control inflation to reduce interest rates thus stimulating private investment and other economic activities To solve unemployment, Keynes theorized Theory of Employment (Keynes, 1936)

The volume of jobs depends on effective demand (Effective demand is intersection point

of aggregate supply with aggregate demand when aggregate supply equal to aggregate demand), the number of workers is to attract more and vice versa Consumer tends to reflect the relationship between income and wealth of consumer for income derived from

it The influencing factors such as: Income of the population, the objective factors affecting income (taxes, prices, changes in nominal wages), and subjective factors influence consumer Propensity to save reflects the correlation between income and savings: Personal savings and Saving the way enterprises and organizations When employment increases, the total real income increases So reduce consumption relative

makes effective demand reduction, production scale shrinking, reducing the lead to reduced income Investment is a measure of an important role in creating jobs; the increased investment will make up for the shortage of consumer demand The degree of balancing jobs depends on the volume of current investment, which the current volume of investment depends on investment stimulation; the stimulation of investment depends on the effectiveness of interest rate limits

Thus, according to Keynes to prevent unemployment and to increase investment crisis – increased demand for additional workers – increasing the salary fund – rising consumer – price increases – increasing the scale of production – increased employment – income (From the 1930s until the 1970s)

2.2.2 Cost-push Inflation: Decrease in Supply

Cost-push inflation is a phenomenon present in the market prices pushed up production costs by increasing the average rate that the economy can withstand: Rising prices of fuel and raw materials; Wage growth rate greater than the growth rate of labor productivity equilibrium; Large depreciation expenses while the obsolete equipment, material-consuming and labor but low productivity; Indirect costs are too high proportion of total costs allows making (C + V) is too large proportion of the total price (C + V + M) Characteristics of cost-push inflation is usually takes place in conditions of production has not reached the level of potential output value compared with the current capacity Inflation usually occurs simultaneously pulling the recession speed is very fast and difficult to overcome than the anti-inflation demand-pull (Gordon, 1988)

Inflation caused primarily by a decrease in aggregate supply Prices of goods and services increased as wages are pushed up by industrialization, or by union bargaining power Balance of payments, exchange rates, global prices and so is also considered to cause increased costs

Structuralisms’ argument

According to structuralisms, inflation is a companion inevitable process of growth When industrialization took place, the agricultural sector will be narrowed to expand the manufacturing sector As a result, demand for intermediate and capital imports increased

It is the supply constraints in the economy Furthermore, the agricultural sector shrink reduce food supplies for domestic consumption; therefore, food prices will rise Then, real wages will go down with rising food prices A demand real wage resistance will lead

to wage-price spiral that propagate through the indexing mechanism A supply-side shock sparks off the process of chronic inflation (Myrdal, 1968; Streeten, 1972; Kirkpatrick and Nixon, 1976)

Exchange rate can affect the price of imported goods Inflation can occur when there is a devaluation of the local currency The devaluation of the national currency of a price increase leads to imported food, raw materials and equipment, especially in a small open economy is considered to copy price Such increase is the result of an increase in production costs; and also increased the price of competing imports According to this argument, the depreciation can cause the collapse of food Again, real wage resistance requirements of the increase in nominal wages which leads to price increases Then, the spiral appears salary and foreign exchange result of chronic inflation Thus, structuralisms counting exchange rate is a determinant of inflation Balance of payments problems are also high as a source of inflation According to balance of payments restrictions, developing countries tend to depreciate their currency to get enough foreign currency to close their balance of payment deficit Such actions explain chronic inflation

in some developing countries (Bretton Woods Agreement, 1944–1971)

2.2.3 Market Power Theory of Inflation

In an economy, as a group or a seller together decide on a new rate that is different than the competitive price, then the price is known as the as market power price This group keeps prices they can earn maximum profit without any concern about the purchasing power of consumers The salary increases were offset by increasing product prices With

the increase in the income of the individual, their purchasing power also increased, which further results in inflation In addition, a number of economists have concluded that fiscal policy and monetary are not applicable in real-life situations such as these policies do not have the ability to control the increase in prices These policies will only work when prices rise due to the increase in demand (Keynes, 1936)

Moreover, these policies cannot be applied to increase the oligopoly in the price, which is due to increased production costs Monetary policy can reduce inflation by increasing interest rates and regulate the flow of credit in the market However, it will not affect the oligopolistic prices as costs are transferred to the prices of goods and services

2.2.4 Okun’s Law

In economics, Okun’s law (named after Arthur Melvin Okun, who proposed this law in 1962) said that the relationship between unemployment and the decline of national output

1 is drawn from experimental observations Okun’s law, exactly, is often seen as a form

of “rule of thumb” because it is roughly estimated to be derived from empirical observation rather than from theory Called approximation because there are other factors (such as productivity) affect the results In the original report by Okun stated that 2% increase in production will lead to unemployment reduction cycle 1%, of the participants

in the labor force increased by 0.5%, the number of hours worked by each employee up 0.5%; and output per hour worked (labor productivity) increased by 1% Okun’s law says the unemployment rate rose to a one percentage point would result in real GDP growth fell by 2% However, researchers are still debating when considering the impact of national time frame and picking up results (Okun, 1962)

The relationship was tested by regression growth rate of GDP or GNP according to the change in the unemployment rate Prachowny estimated that output fell 3% on the unemployment rate leads to an increase of 1% However, the authors also argue that the actual output decline largely due to the influence of other factors besides unemployment While holding other factors constant, the authors estimate the output decline 0.7% reduction (Prachowny, 1993) In the US, the decline in output seems to tend to diminish

over time According to Andrew Abel and Ben Bernanke, the time frame closer study estimated decrease of about 2% corresponding to each 1% increase in unemployment (Abel and Bernanke, 2006)

There are several reasons why GDP may increase/decrease faster than the corresponding decrease/increase of the unemployment rate: When unemployment rises, currency multiplier effect reduced by the workers tends to reduce spending A waiver of unemployed people looking for jobs, and are not counted in the labor force Not the unemployment statistics Workers may work fewer hours Labor productivity can be reduced, perhaps because employers maintain more workers than necessary

One implication from the above analysis that the increase in labor productivity, or scaling the workforce may lead to net volume growth, but the unemployment rate did not decrease net (the phenomenon of “jobless growth”)

2.2.5 Phillips Curve

Phillips curve indicates the relationship between unemployment and inflation The line is named Alban William Phillips, who in 1958 conducted empirical studies based on data in England from 1861 to 1957 and found a negative correlation between the unemployment rate and speed nominal wage increases US economic phenomenon 1960s the inflation rate is high despite GDP growth rate is also high To explain this phenomenon, the economists of the school of macro economists have used synthetic research results of Phillips and Phillips made the downward sloping curve to the right on a two-dimensional graph with horizontal axis is the unemployment rate and the vertical axis is the level of inflation On the way is the combination of inflation and unemployment Along the Phillips curve, whenever the unemployment rate goes down, the rate of inflation will rise; and vice versa Since then, the school of economics synthetic macro argument that to reduce unemployment the government has used aggregate demand management policies, but because the unemployment rate has negative relationship with sustainable inflation rate development, economic growth should naturally cause higher inflation Inflation is the price to pay to reduce the unemployment rate The original Phillips Curve, based on

empirical evidence, said a trade-off between unemployment and inflation The downward sloping curve from left to right and seemed to provide policy makers with a simple choice between inflation and unemployment (Phillips, 1958)

Monetarism has refuted the above reasoning of the economics school of aggregate macro They said that the Phillips curve above is only short term Phillips curve Friedman, 1968

came up with the concept of natural rate of unemployment, according to which the labor market in equilibrium still unemployed This is a voluntary unemployment Therefore, in equilibrium, the unemployment rate is still a positive number And when the economy is balanced, then inflation does not occur Short-term Phillips curve should slope down and cut a horizontal axis in the value of the natural rate of unemployment As long as the government adopts measures to bring the unemployment rate below this level, the price will raise (inflation) and a shift to the left along the short-term Phillips curve

After inflation accelerates, individuals with typical economic behavior estimate inflation will continue to accelerate While nominal wages constant, inflation means that real wages paid to them is reduced They will reduce the labor supply, even voluntarily

Unemployment Rate

New Short run Phillips curve

NAIRU or Long run Phillips curve

Inflation

Rate

Initial Short run Phillips curve

The Phillips curve

unemployed Consequently, in the long-term, the unemployment rate remained at a natural rate of inflation is being raised constantly State policy is so effective only in the short-term; there is a failure in the long-term The set of points corresponding to the natural rate of unemployment and the inflation rate was pushed up continuously form a vertical line This road is called long term Phillips curve

2.3.1 Money Supply and Inflation

According to the theory of Milton Friedman’s money, 1956, the relationship between money supply and inflation is expressed through quantitative equation:

MV = PY Where: M is the amount of money

V is the rotation of money

P is the price

Y is output (real GDP)

Quantitative equation can be written as a percentage as follows:

(% Change in M + % change in V = % change in P + % change in Y)

This formula shows the relationship between the fluctuations of supply factors: Money, the rotation of money, prices and real GDP Typically, the rotation of money, also known

as the cash flow speed V has not changed much over the years Suppose V unchanged, while the growth rate of prices growth in money supply minus the growth rate of real GDP Thus, inflation occurs when money supply growth rate faster than the growth rate

of output Y In the case of the economy hit a fixed annual yield, the rate of price increase

in the main rate of money supply, money supply growth rate determines the inflation rate

Thus, in theory, the amount of money in the long run, inflation is always a monetary phenomenon and inflation was largely determined by the growth rate of the money supply The statistical analysis also showed that exist pretty close relationship between money growth and inflation in the country and in the extended period

2.3.2 Inflation and Exchange Rates

Since the 1960s of the twentieth century, the economists around the world have studied the relationship between two variables exchange rates and inflation Another explanation

is the difference in the rate of change in prices at domestic and abroad, the difference in inflation rates in the percentage depreciation or appreciation of the exchange rate (Purchasing Power Parity theory, Cassel, 1918) However, due to specific economic, political and social culture of each country is different, so at a time of inflation and changes in the national exchange rates also different Therefore, the study of inflation and exchange rates by qualitative methods, quantitative, or a combination of both methods of macroeconomic variables in each economy has always been necessary for every country While holding steady exchange rates then policy makers will be boost the public’s confidence in the local currency, especially in countries where the level of “dollarization”

of high finance system main In the inflationary spiral and exchange rates, the question is what are the cause indicators and metrics that result To answer this question needs to identify the factors causing inflation and the factors that affect exchange rates Some authors in their studies that the stability exchange rates are control inflation However, one of the factors that greatly affect exchange rates is inflation For example, when the risk of high inflation, the public will not believe in the local currency, they will turn to gold and foreign currency reserves sharply, while demand for domestic currency sale and purchase of foreign currency to raise makes exchange rates variables active, in this case shows that inflation is the cause and the result exchange rates fluctuations Can see the relationship between inflation and exchange rates together two-dimensional effect, the typical relationship between macroeconomic variables in the economy

2.3.3 Interest Rates and Inflation

In economics, the Fisher hypothesis (sometimes called the Fisher effect) is proposed by Irving Fisher that the real interest rate is independent of monetary measures, especially the nominal interest rate and the rate the expected inflation rate (Barsky and Summers, 1985)

Inflation is the continuous rise of prices, as the phenomenon of the currency devaluation Theory and practice have admitted close relationship maintained interest rates and inflation Fisher pointed out that rising interest rates during the period of high inflation There are many causes of inflation and also measures to control inflation, including interest rate tool is an effective solution rapidly During inflation, rising interest rates will allow the banking system can attract most of the money in circulation makes money in circulation decreased; Base money and reduce the amount of money supply, inflation was curbed (Fisher Effect, 1930–1939)

2.3.4 Inflation and Government Spending

In the 1930s, John Maynard Keynes (Keynes and Maynard, 1936) argued that government spending, especially to increase spending growth-promoting government by injecting purchasing power into economy According Keynes, the government can reverse the decline recession by borrowing money from the private sector and then pay back the money the private sector through various spending programs

Economic experts believe that excessive government spending is an inflation factor and should be cut The cause of high inflation has a crucial part of the loose fiscal policy reflected in the budget deficit increased continuously over the years Budget deficit occurs when government spending more than the revenue rose Conversely, when a smaller budget, there are some revenue budget bumper (or budget surplus) Budget is one

of the important policy tools of the state to influence the economic development of society When economic output is below potential output level, then the government can increase expenditure budget, approved overspending to promote economic activity Thus,

the budget deficit is not only popular place for poor countries, underdeveloped that happens even for those in the most developed economies (OECD group)

For developing countries, especially for Vietnam, budget often to meet the huge demand for education, health, and infrastructure investments such original: transport, electricity, water etc The main weaknesses in the budget (state budget revenues and insufficient budget deficit must not only domestic and foreign borrowing, but must come from the prerelease) is an important factor causing inflation In terms of revenue, annual revenue loss leads to consequences in many aspects A significant amount of money has not been collected into the state budget in order to meet the budget, causing imbalances between revenue and expenditure, i.e budget deficit Budget deficit increases government debt (if the government has to borrow in domestic and foreign borrowing to offset) or to release the money No small amount remaining losses above plus new money put into circulation will create pressure on inflation In terms of expenditures, investments, inefficient spending contributed to the budget deficit, government debt increases The government must release the money to offset state budget deficit, increase the amount of money in circulation contributed to inflationary pressures

Budget deficit increases government debt (if the government has to borrow in domestic and foreign borrowing to offset) or to release the money No small amount remaining losses above plus new money put into circulation will create pressure on inflation

2.4.1 Evidence from Vietnam

Inflation, according to the general ground that the price is increase, everywhere and at all times as a result of monetary policy This conclusion sounds very extreme, but experience against inflation in the world and in Vietnam before, which the author has contributed to find solutions, shows that this conclusion is correct This conclusion led to

an important corollary that the monetary economist Milton Friedman School of drawn were: monetary policy and pump more credit to promote further economic growth only work short hate; it brings long term and inflation has stagnated development Thus

inflation increases the sense of credit and monetary means to increase the price From here onwards, the inflation means rising prices

Rigid labor markets and changes in labor costs are believed to be the main cause of inflation in developed countries But it is not considered as a main cause of inflation in most developing countries Chhibber and Shafik (1990) argued that “wage push inflation”

is rare in developing countries because wages account for only a small proportion of the national income In the case of Vietnam, a large pool of under-employment in the agricultural sector makes very low price of labor, especially unskilled labor The wage price spiral therefore cannot hold true Similarly, the trade-off between unemployment and inflation suggested by the Phillips curve is not applicable to the case of Vietnam

In Vietnam, the bargaining power of labor is very weak due to the inefficient labor unions

as well as high rates of unemployment Requests from staff salary increases in the private sector so rarely satisfied Meanwhile, wages in the public sector is controlled by the government and sluggish wage increases in response to the price Thus, wages have little power for a period of inflation determination Therefore, cost-push inflation cause inflation expectations are also rare On the other hand, inflation expectations in Vietnam may lead to the request-pull inflation because of hoarding behavior that shows households buy more than their actual needs Wholesalers and retailers as well as are similar actions

The most striking determinants of inflation in the period 1981–1988 is to expand the money supply, while the growth of real output will help reduce inflation (Cong, 1997) Causes of monetary expansion are the lack of monetary discipline for the banking system and the budget deficit problem Therefore, the creation of money is used as a pitcher to solve budget problems

For inflation in 1990, Goujon (2006) developed a model with two decisive factors to elucidate their importance for inflation in Vietnam, related to the phenomenon of dollarization of the economy The study used the Vector Error Correction Model (VECM) to identify two factors: the proportion of the total monetary and exchange in

affecting inflation Despite the limited number of determinants, it is still useful to consider its findings as a reference; especially in the case of research on Vietnam’s inflation in 1990s is scarce

A more thorough investigation of the determinants of inflation is a study of Tho (2001) in the period 1992–1999, which counts actual output, the exchange rate, balance of payments, money supply, and the first investment is the deciding factor Also using Vector Error Correction Model (VECM) for their analysis, the study reflects the significant role in the success rate of inflation reduction targets at this stage The money supply increased inflation but modest extent These findings once again confirm the conclusion Goujon for 1990s However, no causal link was found between the balance of payments and inflation Similarly, the impact of investment, grows at a rapid pace during this period, inflation is not a clear and significant

Inflation in Vietnam during the period February 1996 to April 2005 was analyzed by Camen (2006) The impact of a number of determinants of inflation and the role of monetary factors are the main purpose of his study His article reviewed the index of world prices of petrol and rice, exchange rates, interest rates, credit and monetary aggregate are the factors that influence inflationary A Vector Auto Regression model (VAR) that based on monthly data is used to perform an exploratory analysis of the role

of the explanatory variables in determining inflation in Vietnam Key findings demonstrate the fact that inflation in Vietnam during this period is not only a monetary phenomenon but most is the result of supply shocks These findings affirm the important role of credit to the economy in explaining the CPI after 24 months for the period February 1996 to April 2005 and the period February 1996 to February 2004; credit but only explains a small part of the period February 1996 to April 2003 Similarly, the money supply plays a role in causing inflation

Different from the findings of Camen, the IMF’s research emphasizes the role of the movement output and monetary aggregate rather than the role of the exchange rate for the period 2001–2006 The VECM on data about the determinants of inflation from the first quarter of 2001 to the second quarter of 2006is used to analyze the extent to which each

determinants affecting inflation This study focuses on the evolution of monetary aggregates, output gap, and the nominal exchange rate in Vietnam The analysis results show that an important role of monetary factors in explaining inflation in Vietnam; especially the impact of money supply becomes stronger since 2002 The modest positive impact on the national currency depreciation on inflation was also recorded by the model results The slightest movement of the exchange rate during the control samples as well

as prices of some essential items is blamed lessen the impact of changing exchange rates The study also discovered that a narrowing in the output gap relax significant inflationary pressures in the economy In other words, the real GDP growth than potential GDP, CPI inflation will fall

In recent years, especially in 2007, when Vietnam’s inflation spike, inflation in Vietnam has attracted the attention of many researchers and foreign authors So far, there are many research works on inflation in Vietnam was announced However, these works were mostly published articles in magazines, newspapers and in specialized scientific symposium proceedings of a number of agencies and research institutes

2.4.2 Evidence from other Countries

Atesoglu (1999) mentioned about Inflation and Unemployment Models A comparison of the empirical evidence for the two macro models indicates that the alternative Keynesian model is superior to the complete macro model The superiority of the alternative macro-model is apparent in terms of conventional statistical criteria Each equation of the alternative model is highly satisfactory However, in the complete macro model, a crucial component the expectations-augmented Phillips curve has a low explanatory power The superiority of the alternative Keynesian model is a better description of inflation and unemployment The findings may be altered if different forms of the alternative models are compared, and if different empirical concepts of natural output, natural unemployment, and expected rate of inflation are used However, the findings as a whole tend to favor the alternative Keynesian model, which emphasizes the autonomous nature

of wages as a guide to the design and conduct of policies concerning inflation and unemployment The implications of the findings for inflation and unemployment

problems are similar to the solutions advanced by Okun and Weintraub To successfully resolve the inflation and unemployment problems, aggregate demand management policies should be used primarily to stabilize the unemployment rate at its natural level, whereas inflation should be controlled by innovative incomes policies, such as a tax-based incomes policy

Favero (1988) was mentioned that an econometric analysis of the inflation–

unemployment trade-off He did t analyzes a series of specifications for the inflation–

unemployment trade-off from an econometric point of view trying to evaluate them by looking at their goodness of approximation to the GDP Every econometric specification

of the inflation–unemployment trade off held for some period and then broke down; the point of his analysis is to see if an accurate econometric investigation based on diagnostic checking can help the policymaker by giving indications on the reliability of fitted equations and warnings against their potential failure He compares the performance of the Phillips curve with the NAIRU model All the empirical work of the paper is based on annual data for the United Kingdom with a sample 1945–1985

Seyfried and Ewing (2001), their research examined whether the uncertainty associated with the volatility of inflation impacted unemployment in the G7 countries over the last two decades The results indicate that inflation variability had a significant short run effect upon the unemployment rate in Canada, France, Italy, and the United State while

no effect was found for Germany, Japan, or the United Kingdom However, consistent with economic theory, we find no evidence of a long run trade-off between inflation variability and unemployment

Azizi (2004) in an article was discussing the relationship between budget deficits, inflation and money supply growth The main objective of this study was to examine the relationship between theory and empirical deficits and inflation over the period 1975–

2004 He believes that the statistical evidence of the empirical research on the relationship between inflation and the budget deficit ratio to the output shows the relationship between the budget deficit and inflation is not the same for the different

countries The results showed that the relationship between inflation and the budget deficit is not statistically significant

Mostafavi (2007) in a paper considered the causal relationship between inflation and money in Iran For this purpose, a method of Granger causality test of inflation and weak erogeneity Johansen used As a result, short term money can have an impact on inflation, but it is not a long term impact Moreover, monetary policy has been effective in the short term, while the long term monetary policy is ineffective in practice

Andersson, Masuch and Schiffbauer (2009) reported in a comprehensive review of the determinants of inflation and general price level in Europe For this purpose, the dynamic panel techniques used in the period 1999–2006 and concluded that differences in inflation and its persistence in different countries depending on management level general price and market regulations

Bashir, Nawaz, Yasin, Khursheed, Khan and Qureshi (2011) in a paper was using time series data for the period 1972–2010 from the technical and economic Pakistan including the vector error correction integration research and inflation in Pakistan They concluded that the most important variables affecting inflation as output, money supply growth, government spending, and the import price index

Seymur (2011) in his study on the determinants of inflation in the 10 countries in the period from 1996 to 2008 concluded that the growth rate of wages and the exchange rate does not cause inflation, but the main reason for inflation is the growth of money

Umair and Raza (2012) studied the economy of Pakistan using time series data for the period 1981–2010 to find the determinants of inflation in Pakistan They came to the conclusion that the GDP had a significant negative impact on inflation; however, exchange rates, interest rates, budget deficits and unemployment rates have a positive impact and significant inflation in Pakistan

2.5 Summary

A number of key points could be summarized under this chapter The review present here illustrates the wide variety of research that has been conducted over the past few decades and highlights the lack of knowledge in this field The first part of this chapter is to examine the related theories and concepts of inflation of the economy in a country Theoretical background present about Demand-pull inflation, Cost-push inflation, Market Power theory of inflation (Keynes, 1936), Okun’s law, Phillips curve is taken into consideration The second part is mentioned about relationship between inflation with other factors, such as Money supply, Exchange rates, Interest rate, and Government spending The next part is carried out other researchers is relation to the objectives which identified in this research They are empirical studies in Vietnam and other countries

And secondly, the post liberalization period of Vietnam’s economy (1986–2015) is divided by three separate periods for analyzing and determining the main factors which is causing of inflation in each specific period

The first group consists of food products accounted for 47% in the Consumer Price Index (CPI) weights soared due to the impact of avian influenza, the rice price spike due to seasonal shocks

The second group: the material goods, building accounted for 8.2% in the CPI has risen

by steel price increases on the world market Production costs increased due to increased raw material prices and taxes

The third group: transport, post and telecommunications accounted for 10% in the CPI has risen due to the increase in world oil prices Since early 2004, the main collecting excise duty and value added tax has increase, the price of cars and beer respectively 20% and 10% Also starting from the beginning of 2004, the government abolished subsidies for kerosene and preparations and allows the oil companies price-fixing by themselves

but not higher than the state’s basic price 10% and for crude oil is 5% (Statistical Yearbook 2015)

Moreover, in 2007, consumer prices more complicated and tend to rise in the last months Consumer prices in December 2007 increased by 2.91% over the previous month Compared with December 2006, consumer prices increased by 12.63% in 2007, in which the food and catering services increased by 18.92%; housing and construction materials increased by 17.12%; groups of goods and services increased from 1.69% to 7.27% Average consumer prices in 2007 compared to 2006 increased by 8.3%, including food and catering services increased by 11.16%; housing and construction materials increased

by 11.01%; groups of goods and services rose only 3.18% to 6.15% (Statistical Yearbook 2015)

In the first of four months in 2008, commodity prices have been volatile: April 2008 Consumer prices rose month lower than the rate of the previous month but still rising and many items stood at a high price Compared with the previous month, consumer prices rose 2.2% April 2008 (January 2008 increase 2.38%; in February rose by 3.56% in March rose 2.99%) In the group of goods and services, rose sharply and contributed to pushing prices up still is the food groups; housing and construction materials; transportation, postal and food, with the price increase over the previous month respectively: 6.1% increase in food; housing and construction materials rose 2.6%; transport and communication by 2.3%; food up 2.2%; groups of goods and services rose by only 0.4%

to 1% Compared with December 2007, consumer prices rose 11.6% in April, while food grew by 25.1%; food up 15.6%; housing and construction materials rose 10.8%; transport and communication by 9.8%; other groups rose from 1% to 5% Compared with April

2007, consumer prices increased by 21.42%in April 2008 Average consumer prices in four months of 2008 increased 17.6% over the previous four months (Statistical Yearbook 2015)

The increase in commodity prices is a shock on the supply side as prices soared, leading

to inflation

3.3 Trends in Public Expenditure

The budget deficit increased, government expenditure exceeded revenue by 6.6% of GDP, not at 5% as Congress allows, according to calculations by the International Monetary Fund (IMF) Speed increase the budget deficit in eight years remained high at

17 – 18% per year, 26.5% of GDP budget in 2010, approximately 40% to date

In fact, in recent years, although Vietnam has controlled sources state budget overspending from two sources of foreign loans and domestic borrowing money supply pressures added to the market has been significantly reduced, but the pressure increased government spending for regular consumption and investment increased

In terms of expenditure, there is a significant amount of money has been wasted or lost through public investment, spending by state agencies, work inefficiency of state-owned enterprises Investment, inefficient spending contributed to the budget deficit, government debt increases The government must release the money to offset state budget deficit, increase the amount of money in circulation contributed to inflationary pressures

Further tax income is decrease because various tax reductions on imported production decreases with trade agreements Asian Free Trade Agreement (AFTA) and three years (2015–2017) under the Bilateral Trade Agreement (BTA), and the integration into the world economy Crude oil income and the income of the SOEs are reduction On the other hand the state has to spend more because the cost of the reform of enterprises and commercial banks increased the salaries of government employees and build infrastructure

Total State budget revenues in 2007 increased 16.4% estimated over 2006 and by 106.5% year estimate, of which domestic revenues by 107%; Operating revenues by 108.1% import and export; revenue by 156.7% aid Petroleum revenues estimated by 102.1% over the year and lower estimates of the previous year, due to crude oil output fell The total State budget expenditure in 2007 was estimated increasing by 17.9% compared to last year and 106.5% of the yearly estimate, of which spending for investment and

development by 19.2% and 103.2%; recurrent expenditure increased by 15.1% and 107.2%; Aid for debt and 20.5% to the annual plan State budget deficit in 2007 estimated at 14.8% of total expenditures and budget deficit in the year was the first year Congress passed, of which 76.1% was offset by domestic loans and 23.9% from foreign loans

Table 3.3.1 Selected Indicators: Government Expenditure (1996– 2007) (unit %)

Source: Statistical Yearbook 2006

Spending less effective in a long time has made the Incremental Capital – Output Ratio (ICOR) in the investment rising, ICOR in public sector is usually up to more than 10 since 2002 onwards, meaning that 10 unit invest of public sector is to make 1 unit growth, this is the high cost in growth

State sector is a burden on the national budget and hinder economic growth: At the end of

2003, the total capital of the 4,800 state-owned enterprises was USD 12.1 billion compared with USD 13.6 billion of debt Due to the state sector accounted for the bulk of total social investment capital and low investment efficiency should have led to overall capital efficiency of our country is low, this is a direct presence through price increases