Tóm tắt luận án tiến sĩ the real effective exchange rate (REER), the role and application in the vietnamese macroeconomic management

This is the gap that the thesis wants to fill with four focuses: i assessing the REER in the period 2000-2020; ii applying REER to determining the exchange rate misalignment; iii assessi

& TRAINING INVESTMENT

DEVELOPMENT STRATEGIC INSTITUTE

TRAN THI THU HA

THE REAL EFFECTIVE EXCHANGE RATE (REER), THE ROLE AND APPLICATION IN THE VIETNAMESE

The thesis is completed at Development Strategic Institute,

Ministry of Planning and Investment

Instructors:

1 Dr Luong Van Khoi

National Center of Socio Economic Information and Forecast

2 Associate Prof Dr Nguyen Thi Thuy Vinh

Hanoi Foreign Trade University

Referee 1:

Referee 2

Referee 3:

The thesis will be examined by Examination Board of Development Strategic Institute, at ………

The thesis can be found at: ………

PREFACE

1 The necessity of the research:

Exchange rate policy is one of the instruments that play an important role in the macroeconomic management of a country The Real Effective Exchange Rate (REER) compares a nation's currency value against the weighted average of the currencies of its major trading partners REER is used to judge whether the nation's currency is undervalued or overvalued or, ideally, fairly valued through its application in measuring the equilibrium value and detemining the exchange rate misalignment Currently, there are not many studies focusing on the application of REER in Vietnam macroeconomic management This is the gap that the thesis wants to fill with four focuses: (i) assessing the REER in the period 2000-2020; (ii) applying REER to determining the exchange rate misalignment; (iii) assessing the impacts of exchange rate misalignment on Vietnam’s macroeconomic indicators; (iv) providing some policy recommendations on the application of the REER in the Vietnamese macroeconomic management

From the above reasons, the thesis named “The Real Effective Exchange Rate (REER), the role and application in the Vietnamese macroeconomic management” is selected for both the theoretical and practical significance

2 Research objective: The Real Effective Exchange rate and

its applications in the Vietnamese macroeconomic management

3 Research scope: Investigate and assess the role of the REER

of Vietnam in the period of 2000-2020; apply the REER in determining the exchange rate misalignment; assess its impacts on

some Vietnamese macroeconomic indicators such as: growth rate, inflation, trade balance

4 Research methods: The thesis applies both methodsqualitative and quantative analyses

5 Thesis structure: Apart from the Introduction and

Conclusion, the thesis includes 4 Chapters: Chapter I: Literature review on the Real Effective Exchange Rate and its application; Chapter II: Theoretical framework of the Real Effective Exchange rate and exchange rate policy; Chapter III: The current situation of exchange rate policy management and the Real Effective Exchange rate of Vietnam in the period 2000-2020; Chapter IV: Application of the Real Effective Exchange rate in Vietnam's macroeconomic

management and some policy recommendations

CHAPTER I: LITERATURE REVIEW ON THE REAL EFFECTIVE EXCHANGE RATE AND ITS APPLICATION

1.1 The Real Effective Exchange rate and the calculation method

1.1.1 Foreign studies

The theoretical background and the calculation method of

REER were put forward by international organizations, then recognized, expanded and developed in empirical researches According to Ray Barrell and his partners (2005), in the context of competitive economies and deep global intergration, the calculation

of REER becomes more difficult because of lack of data, especially

in trading weights of countries The literature review shows that there are two weighted average methods of a basket of bilateral nomimal exchange rates, including agrithmetic and geometric Luci Ellis (2001) and Ibrahim (2012) pointed out the inadequacies of the former and the advantages of the latter and explained the reasons why the geometric is commonly used by the reseachers

1.1.2 Domestic studies

Some researches calculated REER based on the formula which

is recorgnised in the world, such as: Nguyễn Thị Thu Hang (2011); Nguyen Tran Phuc và Nguyen Duc Tho (2009) Domestic studies also weighed the currencies based on the trade weights, such as UBKTQH and UNDP (2012)), which used the total value of Vietnam’s export and import value with 20 different trade partners

1.2 The relation of the exchange rate with some macroeconomic indicators

1.2.1 Foreign studies

Most of foreign studies pointed out that the exchange rate is one

of the most important tool in the macroeconomic management to

ensure the low inflation rate and the stable financial system, promote the export, control the import and maintain the economic growth rate

1.2.2 Domestic studies

Domestic studies confimed that the exchange rate plays a

important role and has big effects on the macroeconomic indicators

1.3 The equilibrium exchange rate and the estimation models

1.3.1 Foreign studies

- General theoretical background of the equilibrium exchange rate and the estimation models: The estimation methods of the equilibrium exchange rate are originated from the classification of the equilibrium exchange rate into three types: short, medium-term and longterm, respectively represented by the Behavior Equilibrium Exchange Rate (BEER) – by MacDonald (1998); and developped later by Edwards and Savastano (1999), Jongwanich (2009), ; the Fundamental Equilibrium Exchange rate (FEER) - the medium-term equilibrium exchange rate - was firstly proposed by Williamson (1985) and further extended by himself in 1994; the Natural Real Exchange Rate (NATREX) - the long-run equilibrium exchange rate

- by Stein (1994)

- Strong and weak points of the BEER and FEER: On the basis

of considering the advantages, disadvantages of these two methods from empirical studies and the suitability with the Vietnamese economy, the author decided to apply the BEER method and will further clarify the theoretical basis of this method in Chapter II

1.3.2 Domestic studies: From the years of 2000, in Vietnam

some reseaches mentioned about the equilibrium exchange rate such

as Ha Thi Thieu Dao (2011),UBKTQH & UNDP (2012), …

1.4 Exchange rate misalignment and its impacts

1.5 Some limitations of the current studies and issues which will be more developed in the thesis:

1.5.1 Some limitations of the previous studies

1.5.2 New contributions of the thesis and issues to be developed

- Calculating the REER in Vietnam for the period of 2000-2020, disaggregated by weight of export and import value of goods and services instead of using the total import and export value of goods with Vietnamese partner countries as current studies did

- Estimating the exchange rate misalignment based on the selection of the appropriate model and variables for Vietnam economy

- Assessing quantitatively the impacts of exchange rate misalignement to some macroeconomic indicators such as inflation rate, growth rate, export, import; evaluating the possibility of the REER application in the exchange rate regulation which serves for the macroeconomic management

CHAPTER II: THEORETICAL BASIS ON THE REAL EFFECTIVE EXCHANGE RATE AND EXCHANGE RATE

POLICY

2.1 Theoretical basis on the exchange rate and the Real Effective Exchange rate

2.1.1 The nature and classification of exchange rate

2.1.2 The role of the Real Effective Exchange rate in the macroeconomy

The important role in macroeconomic management of the REER includes: (i) Support to the regulation of import and export activities

as well as the adjustment of the currency devaluation or appreciation; (ii) Contribute to stabilize the inflation rate and economic growth; (iv) Be applied to forecast the possibility of a currency crisis or price pressure and inefficient allocation of resources; (iv) Contribute to measure the global competitiveness of a country

2.1.3 Factors affecting the Real Effective Exchange rate:

include the shorterm and longterm factors The shorterm factor is: the difference between domestic and foreign real interest rate The longterm factors consist of the openess of the economy (OPEN); Terms of trade (TOT); Govermental exxpenditure (GEXP); Difference between production capacity (PROD); the ratio between domestic and foreign government debt ( ); Net foreign assets (NFA)

2.2 Exchange rate policy

2.2.1 Definition: a system of rules and íntruments which are

used by a country's monetary authority to regulate exchange rates to obtain a country's goals in a given period

2.2.2 The main content: The exchange rate policy consists of

two main contents: the selection of the exchange rate regime and the intervention and regulation of the exchange rate by instruments

2.3 The equilibrium exchange rate

2.3.1 Defintion

The equilibrium exchange rate is the exchange rate which is freely determined at the market equilibrium exchange rate Clark and MacDonald (1998) suggested that the equilibrium exchange rate is determined by the following equation.:

In which:

: the equilibrium exchange rate at the period t;

Z: vector consisting of the basic economic variables that are likely to affect the equilibrium exchange rate in the medium and longterm;

T: vector consisting of the temporary variables (which includes current and lagged variables as well as dynamic effects from the basical variables, Z) that affect the equilibrium exchange rate in the short term

: random noise

𝛽 và 𝜃: the coefficients vector

2.3.2 The approachs to determine of the equilibrium exchange rate

2.3.3 Behavior Equilbrium Exchange Rate (BEER)

2.3.3.1 Defintion and estimating methods

Clark and MacDonald (1997) confirmed that to evaluate the present value of exchange rates, a reduced equation that explains the behavior of the real effective exchange rate in the sample period can

be described as follows:

In which:

vector which consists of the basic economic variables that

affect the equilibrium exchange rate in the longterm;

vector which consists of the basic economic variables that

affect the equilibrium exchange rate in the medium term;

và the coefficients vector

T vector which consists of the basic economic variables that

affect the equilibrium exchange rate in the short term

the coefficients vector

: random noise

To better illustrate the BEER approach, Clark and MacDonald (1998) assumed these variables that are determined in the long run of the vector (Zt) including TOT, TNT and NFA),

Jongwanich (2009) used the variable PROD instead of TNT, which has a negative effect on REER through the Balassa-Samuelson effect (Obstfeld and Rogoff, 1996) Therefore, the BEER equation includes the variables:

2.3.3.2 Empirical studies applied the BEER in Asian countries

2.4 The exchange rate misalignment

2.4.1 Definition

Exchange rate misalignment occurs when the real exchange rate deviates from the real value at equilibrium level To understand in a simple way, when a currency is nominally overvalued or overvalued relative to the market equilibrium rate, it is obvious that the currency's real value deviates from the equilibrium level

2.4.2 Impacts of exchange rate misalignment to the economy

Exchange rate misalignment can affect the economy through 4 transmission channels: directly impacts to commodity price, thereby affecting import and export and the country's competitiveness with the rest of the world; has effects on domestic and foreign investment, thus impacts to the capital accumulation process; negatively affects the economic growth; causes distortions in the allocation of production resources in industries and thereby leads to economic instability

CHAPTER III THE CURRENT SITUATION OF THE EXCHANGE RATE MANAGEMENT AND THE REAL EFFECTIVE EXCHANGE RATE OF VIETNAM IN THE PERIOD OF 2000-2020

3.1 The current situation of the exchange rate policy and exchange rate movements in the period of 2000-2020

3.1.1 Overview of macroeconomic situation in the period of 2000-2020

3.1.2 The current situation of exchange rate policy and exchange rate movements in the period of 2000-2020

The exchange rate mechanism in Vietnam before 2015 which aimed at stabilizing the VND/USD nominal exchange rate led to many inadequacies After 2015, the shift to a new mechanism which anchoring the exchange rate with a basket of currencies (8 currencies) helped to keep the exchange rate more stable and flexible However, many studies showed that this mechanism remained peg the VND to the USD (Trần Thị Thanh Huyền, 2018) Meanwhile, in the context of deeper integration and Vietnam's financial and monetary market increasingly affected by the global economy, it is necessary to have an exchange rate mechanism that properly reflects the rules of market movement Therefore, the current basket of the central exchange rate should be expanded to fully and objectively reflect the trade value of Vietnam with trading partners, thereby provide more reliable and realistic information to implement active, effective and appropriate exchange rate management in accordance with the intergration trend

3.2 The Real Effective Exchange rate of Vietnam in the period of 2000-2020

The thesis applies the formula of OECD (2010) to calculate the REER of Vienam in the period of 2000-2020, in which using the geometric weighted average method

In which:

- t is time;

- n is number of main trading partners of Vietnam;

- the real effective exchange rate of Vietnam in the time

- is the nominal bilateral between country (region) j and

Vietnam, measuring by the price of a foreign currency unit of a

country (region) j per VND in the time t;

- và are alternatively the consumer price index of country

(region) j and Vietnam in the time t;

- is the weight of the currency of the country j in the time t, corresponding to the trade ratio of the country (region) j in the total trade value of Vietnam with trading partners in the time t

- The range of countries: The author uses the bilateral exchange rate of 32 foreign currencies of 50 largest trading partners of Vietnam (in which 19 countried belong to the Eurozone) with the total annual trading ratio accounting for more than 98% the total trade value of Vietnam

The data which is used to determine the trade weights is extracted from the Direction of Trade Statistics (DOT) of IMF; while the data of bilateral exchange rate between currencies with USD, CPI index of Vietnam with partner countries are from the International Financial Statistics (IFS)/IMF

- Time scope and data frequency: The author calculates the REER of Vietnam using quartely data from Q1/2000 to Q4/2020 The trend of the REER with 32 currencies is described at Figure 3.10 The REER results which based on purchasing power