UNIVERSITY OF ECONOMICS INSTITUTE OF SOCIAL STUDIES HO CHI MINH CITY THE HAGUE VIETNAM THE NETHERLANDS VIETNAM- NETHERLANDS PROGRAMME FOR M.A IN DEVELOPMENT ECONOMICS THE RELATIONSHIP BETWEEN INFLATION AND INFLATION UNCERTAINTY IN VIETNAM OVER THE PERIOD 1995-2010 BY NGUYEN VAN DUNG MASTER OF ARTS IN DEVELOPMENT ECONOMICS HO CHI MINH CITY, NOVEMBER, 2011 UAN VAN CHAT LUONG download : add luanvanchat@agmail.com UNIVERSITY OF ECONOMICS INSTITUTE OF SOCIAL STUDIES HO CHI MINH CITY THE HAGUE VIETNAM THE NETHERLANDS VIETNAM- NETHERLANDS PROGRAMME FOR M.A IN DEVELOPMENT ECONOMICS THE RELATIONSHIP BETWEEN INFLATION AND INFLATION UNCERTAINTY IN VIETNAM OVER THE PERIOD 1995-2010 A thesis submitted in partial fulfilment of the requirements for the degree of MASTER OF ARTS IN DEVELOPMENT ECONOMICS By NGUYEN VAN DUNG Academic Supervisor: DR. TU vAN BiNH HO CHI MINH CITY, NOVEMBER, 2011 UAN VAN CHAT LUONG download : add luanvanchat@agmail.co TABLE OF CONTENTS List of Tables lV List of Figures lV List of Acronyms v Acknowledgement Vl Abstract Vll Chapter 1: Introduction 1 1.1 Background of the Study 1 1.6 Justification of the Study 4 1. 7 Scope of the Study 4 1.8 Organization of the Study 4 Chapter 2: Literature Review 6 2.2 Theories about the inflation-inflation uncertainty relationship 7 2.3 Approaches to estimate inflation uncertainty 9 2.4 Methods to test the causal relationship between inflation and inflation uncertainty 12 2.5 Empirical studies about the inflation-inflation uncertainty relationship 13 2. 7 Chapter Summary 26 Chapter 3: Research Methodology and Data 27 3.2 Unit root testing 27 3 .3 Diagnostic tests for serial correlation, heteroskedasticity and ARCH effects 29 11 UAN VAN CHAT LUONG download : add luanvanchat@agmail.4 Measuring inflation uncertainty 30 3 .5 Granger causality tests 31 3.3 Chapter Summary 33 Chapter 4: Findings and Discussion 34 4.2 Unit root testing 35 4.3 OLS estimation of AR(p) model of inflation 36 4.4 Measuring inflation uncertainty 39 4.5 Granger causality tests 46 4.
6 Comparison with previous studies 48 4.7 Chapter Summary 49 Chapter 5: Conclusion and Policy Implications 51 5.3 Limitation and Further Studies 55 5.2 Further Studies 55 References 57 111 UAN VAN CHAT LUONG download : add luanvanchat@agmail.co List of Tables Table 2.1: Early empirical studies about the inflation-inflation uncertainty relationship .2: Empirical studies about the inflation-inflation uncertainty relationship using the simultaneous estimation approach .3: Empirical studies about the inflation-inflation uncertainty relationship using the two-step approach with symmetric GARCH models to estimate inflation uncertainty .4: Empirical studies about the inflation-inflation uncertainty relationship using the two-step approach with the extensions of GARCH model to capture the. In asymme tric. fl at'Ion unce rtain .1: Unit root tests .2: Lag selection of AR(p) process .3: OLS estimation of AR(13) model .5: Granger Causality Tests .46 List of Figures Figure 4.1: Descriptive statistics of inflation in Vietnam 1995-2010 .2: Average rates of inflation by month in the period 1995-2010 (%) .3: Inflation uncertainty of the AR(13)-EGARCH(1,1) model.4: Inflation and inflation uncertainty over the period 1995-2010. 46 IV UAN VAN CHAT LUONG download : add luanvanchat@agmail.co List of Acronyms AIC: Akaike Information Criterion AR: Autoregressive ARCH: Autoregressive Conditional Heteroskedasticity EGARCH: Exponential Generalized Autoregressive Conditional Heteroskedasticity GARCH: Generalized Autoregressive Conditional Heteroskedasticity HQ: Hannan-Quinn criterion OLS: Ordinary least squares PARCH: Power Autoregressive Conditional Heteroskedasticity SBV: State Bank of Vietnam SC: Schwartz criterion TARCH: Threshold Autoregressive Conditional Heteroskedasticity UK: the United Kingdom US: the United States of America v UAN VAN CHAT LUONG download : add luanvanchat@agmail.co Acknowledgement I would like to express my sincere gratitude to my supervisor Dr.
Tu Van Binh who gave me valuable guidelines, comments, suggestions, and inspiration for the successful completion of this study. Besides, his friendly and inspiring approach has given me a great deal of encouragements to overcome difficulties in the whole research process. I am also thankful to all lecturers and program administrators in the Vietnam- The Netherlands Program for M. in Development Economics.
They gave me wonderful knowledge and help me kindly during the course. Last but not least, I would like to express my appreciation to my family, my friends who have given me a lot of support when I pursue my studies at the program. Vl UAN VAN CHAT LUONG download : add luanvanchat@agmail.co Abstract The study investigates the causal relationship between inflation and inflation uncertainty in Vietnam over the period 1995-2010 using the two-step procedure. Inflation uncertainty is modeled by both symmetric model (GARCH(1,1)) and asymmetric models (TARCH(l,l), PARCH(l,l), EGARCH(l,l)).
The results indicate that there exists an asymmetric impact of inflation shocks on inflation uncertainty, implying that a positive inflation shock induces higher inflation uncertainty, while a negative inflation shock induces lower inflation uncertainty. Based on information criteria including AIC, SC, and HQ as well as diagnostic tests, AR(13)-EGARCH(l,l) is considered the best model to model inflation uncertainty. Then Granger causality tests are employed to test the causality between inflation and inflation uncertainty (estimated by the AR(13)-EGARCH( 1,1) model). The results support that a rise in inflation significantly leads to more inflation uncertainty, which confirms the Friedman-Ball hypothesis; and increasing inflation uncertainty leads to more inflation, confirming the Cukierman-Meltzer hypothesis, which indicates an "opportunistic" State Bank of Vietnam.
The policy implication is that the monetary authorities have to keep inflation low, stable and predictable to eliminate the negative impact of inflation uncertainty. Key words: inflation, inflation uncertainty, relationship, GARCH models, Granger causality tests Vll UAN VAN CHAT LUONG download : add luanvanchat@agmail.co Chapter 1: Introduction 1.1 Background of the Study Vietnam experienced hyperinflation m the late 1980s (approximately 300%/year) and early 1990s (approximately 50%/year) due to bad weather, weak financial system, and especially poor governance of the authority. The year 1995 marked an important turning point when hyperinflation was completely controlled and Vietnam began its deep international integration (i. formally normalized diplomatic relations with the US and became the full member of ASEAN).
The years after 1995 witnessed the 1997-1998 Asian Financial Crisis and its consequences to the world prices and aggregate demand. Because of the negative consequences of the crisis, both demand for Vietnamese goods and domestic demand declined. This period was marked by low inflation with mild deflation in 2000 (-0.5%) despite rapid monetary and credit growth (approximately 30- 40%/year) and VND's sharp devaluation (approximately 36%) in the period 1997- 2003 (Nguyen & Nguyen, 2010). After the period of stably low inflation, inflation began increasing sharply with 9.
When the negative impact of the Asian crisis declined, demand began to rise. Demand increase and the rise of salary in both the public and FDI sector in 2003 pushed the prices to rise. Additionally, supply shocks (due to bird flu and bad weather) contributed to the price increase. The government considered supply shocks mainly responsible for inflation.
Food prices increased by 15.5% compared with the general inflation rate of 9.5% and inflation of non-food products was 5. For the fear of increasing inflation, State Bank of Vietnam (SBV) implemented tightening monetary policy, making interest rates increase slightly, and fixed the exchange rate since 2004. The rigid management of exchange rate untillate-2008 did not stabilize inflation as in the period 2000-2003. Inflation, after 1 UAN VAN CHAT LUONG download : add luanvanchat@agmail.co declining slightly in 2006, increased sharply to 12.6% in 2007 and up to 20% in 2008 (Nguyen & Nguyen, 2010).
• There are many causes of high inflation in the period 2007-2008, which include the sharp increase of minimum wage rate, sharp rise of international commodity prices, lax and inflexible monetary policy, rigid exchange rate management, and the opening of Vietnam to the world economy since Vietnam's join the WTO in late-2006, leading to indirect investment flows of foreign countries into Vietnam, pushed stock prices and asset prices increase dramatically. To stabilize the exchange rate, SBV had to pump a large amount of money into the economy (approximately VND 145 thousand billion), contributing to more severe inflation. In fact, the increase of money supply and credit growth in the economy in the last decade was very strong, especially in 2007 when M2 increased by 47% and credit growth increased by 54% (Nguyen & Nguyen, 2010). Impacts of the 2007-2008 Global Financial Crisis made inflation slow down in Vietnam since late-2009.
The decrease of international prices and total demand made Vietnam reverse alarming trend of increased inflation since 2008. However, for fear of recessionary impacts, the government introduced the stimulus package since the second quarter of 2009, which made money supply and credit soar. The early months of 2010 saw relatively stable inflation rates. However, inflation increased sharply since September 2010 and reached 11.75% for the whole year.
In general, the period 1995-2010 is the relatively stable inflation time compared with the hyperinflation period in the late 1980s-early 1990s. Inflation is rather low in a decade from 1996 to 2006. However, high inflation has returned to the Vietnamese economy since 2007 with two-digit inflation rate, which poses many threats to the economy.2 Problem Statement Inflation is a worldwide problem that causes a negative impact on every economy in the world. In the Vietnamese case, the country incurred relatively high 2 UAN VAN CHAT LUONG download : add luanvanchat@agmail.co level of inflation during a long period 1995-2010, on average 7%/year, which is more persistent and more volatile than that of other countries in the Southeast Asia region.
Inflation may result in many serious consequences. Among them, inflation uncertainty is regarded as one of the most significant consequences of inflation. Inflation uncertainty is defined as a situation in which future price levels are unpredictable and the general public does not know whether inflation will increase or decrease in the future. As a result, it affects negatively consumers and producers' decisions about saving and investment in the future, which leads to the loss of economic well-being (Golob, 1994).
As a result, understanding the nature of the relationship between inflation and inflation uncertainty is essential for improving current policies to control inflation and stabilize the macro economy.3 Research Objectives The specific objectives of the study are to (i) examine whether there is an asymmetric impact of inflation shocks on inflation uncertainty in Vietnam • (ii) test whether inflation causes inflation uncertainty in Vietnam (iii) test whether inflation uncertainty causes inflation in Vietnam (iv) offer some policy implications to better control inflation and inflation uncertainty 1.4 Research Questions Main question: (i) What is the relationship between inflation and inflation uncertainty in Vietnam over the period 1995-2010? Sub-questions: (i) Is there an asymmetric impact of inflation shocks on inflation uncertainty? (ii) Does inflation cause inflation uncertainty? (iii) Does inflation uncertainty cause inflation? 3 UAN VAN CHAT LUONG download : add luanvanchat@agmail.5 Research Hypotheses The null hypotheses are as follows: H0 : Inflation does not cause inflation uncertainty. H 0 : Inflation uncertainty does not cause inflation.6 Justification of the Study This study makes a major contribution in two aspects as follows. First, there have been many empirical studies on the relationship between inflation and inflation uncertainty. However, most of the studies mainly focus on developed countries with relatively low inflation rates (Jiranyakul & Opiela, 2010).
There are still few studies about this issue for developing countries with relatively high inflation rates. In the case of Vietnam, there are still no published studies about this topic. Therefore, this paper contributes to the literature as one of the first comprehensive analysis about this issue in the Vietnamese case. Second, the evidence from this study is informative and useful for monetary authorities so that they can understand the nature of the inflation-inflation uncertainty relationship in Vietnam during the past sixteen years empirically.
As a result, they have reliable foundation to propose and implement policies to control inflation better.7 Scope of the Study The study will investigate the inflation-inflation uncertainty relationship in Vietnam during the period 1995-2010.8 Organization of the Study The remaining of the paper is structured as follows: Chapter 2 gives a review of definition, consequences, and methods to model inflation uncertainty. In addition, theories, empirical studies about the inflation-inflation uncertainty relationship and methodology to test this relationship are also presented.