The Causes of Recent Inflation in Vietnam: Evidence from a. VAR with Sign Restrictions

Transcription

1 The Causes of Recen Inflaion in Vienam: Evidence from a VAR wih Sign Resricions Tuan Khai Vu Faculy of Economics, Seikei Universiy Firs version: Jan,. This version: May,. (Preliminary. Commens are welcome.) Absrac This paper sudies he causes of high and chronic inflaion in Vienam in recen years using he srucural VAR mehod idenified by sign resricions. The sign resricions are drawn from a New Keynesian small open economy DSGE model buil and calibraed o he daa of Vienam. Variance decomposiion resuls show ha supply shocks and demand shocks seem o explain a large par of inflaion over he whole sample period, while he conribuion of moneary shocks is smaller bu no negligible. Hisorical decomposiion resuls show ha demand shocks and, o a lesser exen, moneary shocks seem o be he main deerminans of inflaion in he period Q-8Q3, while supply shocks appear o be more imporan in he period 8Q-Q. Keywords: VAR, sign resricion, New Keynesian DSGE model, inflaion, Vienamese economy. JEL codes: E3, F33, F.. Inroducion High and somewha persisen inflaion has been one of he mos challenging macroeconomic issues in Vienam over he las few years wih he rae being 8.3%, 3.%,.9%, and.8% in he years 7, 8, 9, and, respecively, which is much higher han ha in oher neighboring Eas Asian counries in he same period. This has direcly affeced he lives of he people, especially he poor, and has raised a difficul ask for he governmen who is sruggling o mainain macroeconomic sabiliy. A naural quesion arises as o wha has caused his inflaion. The likely deerminans of he inflaion ha have been argued so far vary according o people and organizaions ha argued hem. Governmen officers ofen blame facors such as he soaring prices of oil and oher commodiies in he world marke, he prevalen of SARS, animal diseases and so on for he high inflaion, while some economiss argue ha he inappropriae conduc of moneary and exchange rae policy of he moneary auhoriy should have been he main causes. Some oher people asser ha expansionary fiscal policy in he form of huge invesmen in large sae-owned firms should have played an Assisan Professor. Mailing address: 3-3-, Kichijoji-Kiamachi, Musashino-shi, Tokyo, Japan, vkhai a econ.seikei.ac.jp.

2 imporan role. Mos of he argumens, however, were made in he mass media in an informal way. To faciliae he discussion and provide some policy implicaions, his paper aemps o formally analyze he causes of inflaion in Vienam in recen years in boh qualiaive and quaniaive aspecs. To his end, I classify he deerminans of inflaion ino supply, demand, and moneary shocks, and use a novel srucural vecor auo-regression (VAR) mehod o idenify hem from daa on (real) GDP, he CPI and he real effecive exchange rae (REER) of Vienam. A popular mehod o idenify shocks of he ypes noed above is he srucural VAR approach developed by Blanchard and Quah (989) in which shocks are idenified by long run resricions. In he lieraure, Clarida and Gali (99) apply his approach in a hree-variable VAR o idenify supply, demand, and moneary shocks from GDP, CPI, and REER daa. They impose resricions, which are ha in he long run moneary shocks have no effecs on GDP and he REER, and demand shocks have no effec on GDP, based on a sochasic open macro model wih sick prices developed by Obsfeld (98) in he spri of radiional Keynesian macroeconomics. Two problems of his approach can be poined ou. Firs, impulse responses obained are ofen no consisen wih he heory used. For example, he heoreical model suggess ha a favorable supply shock should reduce he price level, bu we observe he opposie in he impulse response funcions (IRFs) of he VAR in many cases. This problem can happen because he mehod does no impose any resricion on he IRFs. The second problem is ha he resricion ha demand shocks have no effec on oupu in he long run may be unreasonable and is no consisen wih he now more popular DSGE models (of eiher New Keynesian or RBC ype). 3 Consider he case of a fiscal policy shock, an imporan demand shock. In a general equilibrium framework in which he budge consrain of he governmen is specified explicily, a permanen increase in governmen spending can have a long run effec on GDP because i would necessarily require an increase in axes, which in urn reduces permanen income of households, and households seeking o sooh ou heir consumpion will reac by increasing heir labor supply, and hus oupu increases. This feaure can be observed in a sandard DSGE model. Moreover, if governmen spending is used o build public physical capial (as in Baxer and King, 993), or human capial, or o promoe echnological progress as ofen observed in realiy, i can affec he supply side of he economy. This is anoher channel hrough which a fiscal policy shock migh have long run effecs on GDP. To overcome hese problems, I uilize he srucural VAR mehod using sign resricions developed by Uhlig (). I build a New Keynesian DSGE model of a small open economy, calibrae and Bayoumi and Eichengreen (993) use a bivariae VAR o idenify supply and demand shocks from GDP and he CPI daa. They derive he long run resricion ha demand shocks have no effecs on GDP in he long run based on he AD-AS model. Many subsequen sudies use eiher wo- or hree-variable VAR wih similar resricions. 3 Noe ha for a hree-variable VAR, he Blanchard-Quah VAR mehod requires exacly hree long run resricions o idenify srucural shocks, and i canno be implemened wihou one of he resricions. For example, he governmen spends is budge o build roads and dams, o subsidy job raining, or o promoe R&D and he adopion of new echnologies.

3 simulae i o he Vienamese daa o obain he IRFs of GDP, he CPI, and he REER o srucural shocks, and hen use hem o impose sign resricions on he IRFs in he VAR o idenify he hree srucural shocks. Thus he mehod I use here produces he IRFs ha are consisen wih he heoreical model ha I base on, and i avoids imposing he unreasonable long run resricion noed above. Having idenified he srucural shocks, I conduc he variance decomposiion and he hisorical decomposiion o analyze he role of each shock in causing inflaion in Vienam. The res of he paper is organized as follows. Secion presens an overview of inflaion in Vienam in recen years. Secion 3 describes he heoreical model from which he IRFs are derived and used o impose sign resricions. Secion explains he srucural VAR mehod using sign resricions. Secion explains he daa and secion analyzes he resuls. The final secion concludes.. An overview of inflaion of Vienam in recen years Figure shows he annual raes of inflaion and growh in Vienam in he period 99-. I can be seen ha during he Asian currency crisis and several years ha followed boh inflaion and growh slowed down. Afer he year growh recovered quickly and sayed high unil he year 7, while inflaion urned negaive in he wo years and (he deflaionary period) and remained under % unil 3. Afer he year inflaion go above %, acceleraed furher and hi he peak of 3.% in 8. In he year 9, wih he macroeconomic policy ighened o figh inflaion and he effecs of he world economic crisis, boh inflaion and growh sared o slow down again. The year saw a resurgence of inflaion which reached.8%, he second highes in he las fifeen years in Vienam. Figure provide a comparison of inflaion beween Vienam and is neighboring counries in he period -. We observe ha he inflaion rae of Vienam was always considerably higher han hose of mos oher Asian counries. This is especially rue for he period 7-9. Simple calculaions show ha he average inflaion rae of he neighboring Asian counries for he period - is.% while ha of Vienam is as high as.%. We conclude his secion by saing ha a quick look a he daa ells us ha inflaion in Vienam has been high and persisen over he las few years. In subsequen secions we proceed o answer he quesion raised a he beginning: wha have been he deerminans behind his inflaion phenomenon. 3. A heoreical model 3. The model In his secion we build a New Keynesian DSGE model of a small open economy, which will be used o sudy how an open economy like ha of Vienam would respond o various ypes of shocks. The model is borrowed from my previous work (Vu, ), and is a varian of he one developed in Shioji, Vu, and Takeuchi (9) wih he main difference being ha he producion srucure of he 3

4 economy is revised o be more suiable for he Vienamese economy. There are four ypes of firms in his economy, and hereafer we shall call hem (and he secor o which hey belong) N, I, M, and X firms. N firms produce a homogenous final good by combining domesic and impored inermediae goods. I firms are domesic inermediae goods producers, and M firms are imporers of foreign inermediae goods. X firms are exporers which produce goods and sell exclusively o he foreign marke. In he shor run, firms in secors I, M, and X migh face sicky prices. Price sickiness is inroduced in he form of he Roemberg-ype quadraic price adjusmen cos, and is mean o give a role for moneary policy in affecing he real side of he economy. Moreover, price sickiness in secors M and X is mean o capure he possibly incomplee and slow pass hrough of he nominal exchange rae o impor and expor prices, which will be imporan o he dynamics of macro variables in response o shocks. On he invoicing currency used in inernaional rade, considering he case of an emerging counry like Vienam, i is reasonable o assume ha expored and impored prices are invoiced in he foreign currency. This corresponds o he case of local currency pricing (LCP) on he expor side and producer currency pricing (PCP) on he impor side. Households Households in he economy live infiniely and are disribued in he range [,]. They work, consume goods, pay axes o he governmen, and save in he form of holding money and bonds using heir wage income and dividends received from domesic firms which hey own. They derive uiliy from consuming goods and holding money, and disuiliy from working. The expeced life-ime uiliy of a represenaive household is U = E u C L M P, () = β (,, / ) where E denoes expecaion a ime, β is he subjecive discoun facor, and C, L, and M / P uiliy is specified as are consumpion, work hours, and real money holdings, respecively. The period C L ( M / P) σ + φ + χ σ + φ χ (,, ) = ωl + ωm u C L M m, () where σ is he inverse of he ineremporal elasiciy of subsiuion, φ is he inverse of Frisch labor supply elasiciy, and ωl and ω are he weighs placed on disuiliy from labor and uiliy from money holdings, respecively. The budge consrain of he household is M + B + S B = ( + i ) B + ( + i ) S B + M + WL +Π PC T. (3) Here M, B, S, P, W, Π, T, and isand for money holdings, bond holdings, he nominal exchange rae (he home currency price of one uni of foreign currency), he price level, he nominal wage rae, profis from firms, he lump-sum ax paid o he governmen, and he nominal ineres rae, respecively. Here we assume ha here are wo kinds of nominal bonds, one denominaed in he home currency and raded only domesically ( B ), and one denominaed in he foreign currency and

5 raded inernaionally ( B ), wih he corresponding ineres raes i and i, respecively. The household seeks o maximize he expeced life-ime uiliy funcion in () subjec o he budge consrain (3) and he period uiliy specified in (). Solving his maximizaion problem yields he following resuls. β C σ + E C σ P P + ( + i ) = () + S S + i = E ( + i ) () W / P = ω L φ C σ () M P l + i m C σ = ω i / χ Here, () is he Euler equaion, () is he uncovered ineres rae pariy condiion, () is he labor supply funcion, and (7) is he money demand funcion. (7) Final good firms (N firms) We assume ha secor N is perfecly compeiive. N firms are disribued in he inerval [,]. They use I goods and H goods (described below) as inermediaes o produce a homogenous good which is consumed by domesic households and he governmen. The producion funcion of a firm n in secor N is assumed o ake he following CES funcional form ( θ )/ θ ( θ )/ θ / θ / θ Yn ( ) = α Yni (, ) di+ ( α) Ynm (, ) dm where Yni (, ) and Ynm (, ) θ/( θ ), (8) are he quaniies of an I good and an M good used as inpus for he producion of firm n, θ is he elasiciy of subsiuion beween hese inpus, and α is a weigh parameer. Prices of N goods are assumed o be flexible. Firm n seeks o maximize is profi aking he prices of is oupu and inpus as given { Y ( n, i), Y ( n, m) } max Π ( n ) PY ( n ) P ( i ) Y ( n, i ) di P ( m ) Y ( n, m ) dm, s.. (8). Solving his maximizaion problem yields he demand of firm n for each of he inermediae goods i and m as follows θ Pi () Y( n, i) = α Y ( n) P, (9) θ Pm ( ) Y( n, m) = ( α) Y ( n) P. () Domesic inermediae goods firms (I firms) We model secor I as monopolisically compeiive wih I firms are disribued in [,], and each of

6 hem uses labor as he only inpu o produce a differeniaed nonradable good which is hen used as inermediae for he producion of N goods. A firm i in secor I uses labor as he only inpu for is producion, and is producion funcion is linear in labor Y() i = A L() i, () I, where A I, is he labor produciviy (or TFP) of secor I, which is he same for all I firms and is given exogenously. The demand for he good of firm i is he aggregaion of demands from all N firms as in (9): θ Pi α P () Pi () Y() i Y( n,) i dn Y( n) dn α = = = Y, P. () N Firm i faces he following Roemberg-ype quadraic per-uni adjusmen cos measured in he unis of he final good when i changes is price [ P () i P () i ] ψ I acp () i = P P ( i) θ, (3) where ψ I is he parameer governing he size of he price adjusmen cos and hus he degree of price sickiness in secor I. The larger is ψ I, he more sicky are prices in secor I. The profi of firm i in period is Π () i = P() iy() i WL() i Pacp() iy() i. () The profi maximizaion problem of firm i is τ τ β s { P () i } τ= s= max V ( i) E ( + i ) Π ( i), s.. ()~(). τ Solving his maximizaion problem gives he following opimal price seing of he firm [ ] θ W () () () () () θ ψ Pi P i I ψip() i P() i P+ i P i Y i + Pi () = + E. () θ AI, θ P () i θ P () i + i P() i Y() i Noe ha in he absence of he price adjusmen cos (i.e. ψ I =), () reduces o he convenional pricing equaion of a monopoly: firm i will se is price as a markup over is marginal cos W /. AI, Exporers (X firms) X firms are monopolisically compeiive exporers and are disribued in [,]. Each of hese firms produces a differeniaed good and sells exclusively o foreigners. Their producion funcion is assumed o be linear in labor inpu as follows Y( x) = A L ( x) () X, where A X, is he exogenous TFP of secor X and is he same for all X firms. The demand faced by firm x is Y x P x Y θx ( ) = ( ) F,. (7) Here P ( x ) is he price of firm x denominaed in he foreign currency, θ X is he price elasiciy of demand for X goods, and Y F, is he foreign aggregae demand which is given exogenously. Firm x

7 denominaes is price in he foreign currency and faces a price adjusmen cos when i changes his price. The per-uni price adjusmen cos faced by firm x and is profi are ψ P ( x) P ( x) X acp ( x) = ( P / S ) P ( x), (8) Π = (9) ( x) SP ( xy ) ( x) WL ( xy ) ( x) Pacp ( xy ) ( x). Solving his maximizaion problem τ τ max V( x) E β is { P ( x) } τ = s= ( ) + Π τ ( x), s.. ()~(9), gives us he following opimal price seing of firm x P ( x) P ( x) θ W / A X X, θx ψx X S θx P ( x) P ( x) = + θ ψ ( ) ( ) ( ) XP ( x) P ( x) P ( x) P+ x P x Y x + E. θx P ( x) + i P ( x) S / S+ Y( x) () Imporers (M firms) M firms are monopolisically compeiive imporers and are disribued in [,]. They buy foreign goods and sell hem o N firms as inermediaes. A firm m in secor M impors a differeniaed foreign good wih he price P, ( m ) denominaed in he foreign currency. We assume ha P ( m) = P for all mwih M, M, M, he aggregaion of demands from all N firms as in (): M θ P m Y α n m dn P P being deermined exogenously. The demand faced by he firm is ( ) Pm ( ) Y( m) = (, ) = Y( n) dn= ( α) YN,. P The per-uni price adjusmen cos faced by firm m and is profi are [ Pm ( ) P ( m) ] ψ M acp ( m) = P P ( m) Π ( m) = P( my ) ( m) SP ( my ) ( m) Pacp( my ) ( m). M, Solving he maximizaion problem τ τ ( ) max V( m) E β + is Πτ ( m), s.. (7)~(), { P ( m) } τ= s= yields he following opimal price seing of of firm m θ θ ψ ( ( ) P M = SP M, + Pm, [ m) P ( m) ] θ θ P ( m) ψ ( ) ( ) ( ) ( ) ( ) MPm Pm P + m P m Y m + E. θ P m) Y( m) ( ) m + i P( θ () () (3) () 7

8 The price adjusmen cos parameer ψ M affecs he degree of pass-hrough of exchange rae changes o impor prices (denominaed in he home currency). If ψ M =, he cos of adjusing price is zero, P ( m ) moves one-o-one wih changes in he exchange rae, and he pass-hrough rae is %. In a more realisic case ψ M is posiive, and if ψ M is large, exchange rae pass-hrough will be slow and incomplee in he shor run. The governmen The governmen collecs axes from households, consu mes N goods and conrols money supply. We assume ha he governmen does no issue bonds, and hus is budge consrain is as follows M M + T = PG (). Noe ha wih infinie horizon and dynamically opimizing agens specified in his model, he Ricardian equivalence holds, ha is, i does no maer wheher an increase in governmen spending is financed by raising ax or by issuing governmen bonds. Thus inroducing governmen bonds will no change he basic resuls below. Marke clearing condiions Final goods marke is in equilibrium when demand for hem from households and he governmen equals he supply of hem by N firms: Y = C + G. () N, The labor marke is compeiive, and labor is freely mobile across secors domesically, bu no inernaionally. Labor marke is in equilibrium when labor demand from I and X firms equals labor supply by households: L = L() i di+ L( ) x dx. (7) In he marke for bonds, because B is raded only domesically, in equilibrium is amoun is zero. We assume ha he ineres rae of bonds denominaed in he foreign currency is relaed o a consan world ineres rae W i i = i + ψ[exp( S B / PY ) ] hrough he uncovered ineres rae pariy condiion wih a risk premium erm W. (8) The risk premium is assumed o depend on he ne foreign asse posiion (as raio o nominal GDP) of he home counry. If he home counry borrows from abroad (so > is he amoun of exernal deb), i has o pay a higher ineres rae o foreigners. The inroducion of he risk premium is o obain saionariy of he model as suggesed by Schumi-Grohe and Uribe (3). In addiion, real GDP, measured in final goods unis and denoed by Y, is defined as Y = Y + ( P Y S P Y )/ P. (9) N, X, X, M, M, B 3. Solving he model, simulaion and resuls I use Dynare o solve and simulae he model. Given he 9 equaions (3)~(), ()~(7),, and 8

9 ()~(9) he exogenous variables M, G, A X, A I, and P M, i is possible o solve for he seady sae and he dynamics of he following 9 endogenous variables Y, C, T, B, i, i, P, S, W, L, Y, Y, Y, Y, L, L, P, P, and P in respon se o changes in he exogenous variables. Since N I M X I X I M X he endogenous variables ener he reduced form VAR model (described in he nex secion) in firs difference form, meaning ha a srucural shock in he VAR can have permanen effecs on he level of he endogenous variables, I confine he simulaion below o he case of once-and-for-all shocks in he heoreical model. In order o simulae he model, firs we need o assign a specific value o each of he parameers. Seing parameers The model is calibraed o he daa of Vienam aken from he Asian Developmen Bank s Key Indicaors for Developing Asian and Pacific Counries (ADB, ). The second column of Table shows he srucure of aggregae demand and exernal deb of Vienam. Two noeworhy poins are ha Vienam appears o be a highly open economy wih rade being roughly one and a half GDP, and ha he exernal deb-gdp raio is as high as.37. The hird column of Table shows he values acually used in simulaion afer excluding invesmen, and adjusing so ha in he seady sae he home counry is owing some deb o he foreign counry, bu i is also running a rade accoun surplus in order o pay exacly he deb service so ha he deb-gdp raio is kep consan. Wih hese daa, i is possible o pin down he basic srucure of he model economy. Oher parameers are se as shown in Table. Mos of he values are quie sandard in he lieraure, see for example Devereux, Lane, and Xu (). The subjecive discoun facor is.98 which implies an annum ineres rae of.8% of he home counry a he seady sae. This, he deb-gdp raio in Table, and he world ineres rae imply a value of. for he deb elasiciy of risk premium parameer. The coefficiens on price adjusmen coss are se o be, bu we will consider several differen values of ψ M in he simulaion below o see how he response of he economy o shocks is sensiive o he pass-hrough of he exchange rae changes o impor prices. Effecs of various ypes of shocks Figure 3 presens he effecs of a permanen increase in he money sock. As expeced, in he shor run, we observe a rise in inflaion, a depreciaion of he home counry currency in boh nominal and real erms, and an increase in GDP and consumpion. Impors increases because of he increase in GDP, which dominaes he increase in expors (due o he depreciaion) causing a fall in he rade accoun. The more sicky are impor prices, he more GDP increases. In he long run, he moneary shock has no effecs on GDP and he real exchange rae. Figure shows he effecs of a permanen increase in governmen spending. We could see ha in he shor run he shock raises GDP and inflaion, while reduces consumpion because households have o 9

10 pay more ax and hus have less permanen income. The effecs on he nominal exchange and he RER are ambiguous, a resul which is also poined ou in Shioji, Vu, and Takeuchi (). Using a New Keynesian open economy model wih an overlapping generaions (OLG) srucure, hese auhors show ha he response of he nominal exchange (and hus he real exchange rae) are sensiive o such facors as he myopia of agens, he degree of price sickiness and moneary policy rule. In he long run, GDP increases because households increase heir labor supply in order o smooh ou consumpion which is reduced by he shock. This las resul is inheried from he RBC model, and is in sark conras wih he radiional Keynesian view in which i is considered ha demand shocks have no effecs on oupu in he long run. Figures and show he effecs of an increase in he TFP of he expor secor and he domesic inermediae goods secor. We could see ha qualiaively he wo TFP shocks have quie similar effecs in boh he shor run and long run: GDP and consumpion go up while inflaion and labor go down. The difference beween he effecs of he wo shocks lies in he responses of he nominal and real exchange rae: a rise in TFP of he expor secor causes an appreciaion of he home currency in boh nominal and real erms, while a rise in TFP of he (nonradable) domesic inermediae goods secor causes a depreciaion. Consider he case of he long run, his laer resul is inuiive if we recall he well known Balassa-Samuelson effecs. The effecs of a fall in he impor price denominaed in he foreign currency is presened in Figure 7. In response o he shock, inflaion and he price level fall because impored inermediaes are now cheaper. GDP and consumpion increase, and he nominal and real exchange rae boh depreciae. Based on he above resuls and discussion, Table 3 summarizes he signs of he IRFs of GDP, he price level, and he real exchange rae, he hree variables which ener he VAR model below. We classify he five shocks discussed above ino hree ypes, namely moneary, demand, and supply shocks. The shaded areas in his able mean ha he signs here are used o impose on he IRFs in he VAR o idenify srucural shocks. Noe ha hese sign resricions are sufficien o disinguish beween he hree shocks. The long run resricions on GDP and he real exchange rae help o disinguish a moneary shock wih he oher wo ypes, while he sign resricions on he price level help o disinguish beween a demand shock and a supply one. The unshaded areas mean ha he signs here are no imposed on he IRFs, bu raher lef open in he VAR.. Procedure o idenify srucural shocks in a VAR wih sign resricions Based on Uhlig (), I follow he seps below o idenify he hree ypes of srucural shocks. Sep : Esimae a hree-variable reduced-form VAR as follows, x = B + B x + B x + + B x + u (),... p p where x = ( log GDP, log CPI, log REER ), denoes quarer, B s ( s =,..., p ) are coefficien marices of size 3 3, p is he lag lengh, and u is a 3 vecor of residuals wih he

11 variance-covariance marix denoed by Σ. The endogenous variables are in firs-order log-differences o ensure saionariy. Assume ha here are hree ypes of srucural shocks, namely supply, demand, and moneary ones, and A is he marix ha relaes he residuals vecor and he srucural shocks vecor ( ε ), ha is, u = Aε. Sep : Use he sign resricions in T able 3 o impose on he IRFs of he hree endogenous variables o he hree srucural shocks. The shor run is defined as =,..., n SR, while he long run (LR) is defined as > n LR, where is he number of periods afer he shock occurs. Sep 3: Based on he esimaed marices ˆΣ and ˆB obained in sep, randomly generae Σ from he inverse Wishar disribuion ( ˆ invw Σ / T, T ) wih T being he sample size, and condiional on Σ, randomly generae B s column-wise vecorized form vec( B ) from he Normal disribuion ˆ NvecB ( ( ), Σ ( XX ) ) wih X being he daa marix. Sep : For each draw ( B, Σ ) generaed in sep 3, randomly generae a large number ( n A ) of marix A using A = AQ where A is he Cholesky decomposiion of Σ, and Q is an orhonormal marix obained b y Q-R decomposing a marix randomly generaed from N(,). Sep : For each draw ( B, Σ, Q), calculae he accum ulaed IRFs of GDP, CPI, and REER o supply, demand, and moneary shocks, and check if he si gns of hese IRFs are consisen wih hose imposed (as in Table 3) or no. If hey are, call he draw ( B, Σ, Q) a valid draw and use i o compue he series of he hree shocks from daa and sore hem. Oherwise, discard he draw ( B, Σ, Q). Repeaing seps hrough many imes we obain a cerain number of valid draws,, and a se of he marices B and Σ, and srucural shocks, which are hen used compue he variance decomposiion and he hisorical decomposiion of inflaion. In n valid he analysis below, I se n =, n = 8, n = 3, and n = for all counries. Given hese las wo parameers, p = 3, following he Schwarz informaion crierion. SR LR valid n Σ becomes endogenous. In addiion, he lag lengh is chosen B A 7. Daa Quarerly daa of real GDP, he CPI, and he REER are used in he VAR model. The sample period is 999Q-Q. Real GDP and CPI daa are aken from he CEIC daabase. REER daa is no available publicly so I calculaed using daa of he rade parners of Vienam and he daa of he exchange raes beween he dong and he currencies of he rade parners. 8 These daa are also obained from he CEIC daabase. Daa on he rade weigh s used o calculae he REER are available from ADB (). Because variables of he reduced-form VAR are in firs-differences and he sign resricions are imposed on levels. For an explanaion of how o compue variance decomposiion and hisorical decomposiion, see Canova (7). 7 The zero resricion is imposed such ha he absolue value of he IRFs subjec o his resricion mus be smaller han. in he long run. 8 These exchange raes are calculaed as he cross raes beween he dong and he currencies of he rade parners of Vienam vis-a-vis he US dollar.

12 . Resuls and analysis Figure 8 shows he responses of GDP, he CPI, and he REER o supply, demand, and moneary shocks in he srucural VAR. We could confirm wih Table 3 ha he IRFs on which he sign resricions are imposed are correcly produced. I is ineresing o look a he oher IRFs on which we do no impose he sign resricions. Two hings can be observed. Firs, he REER increases in response o a supply shocks, suggesing ha, in he case of Vienam, he supply shocks should be eiher shocks o he TFP of he inermediae goods secor or shocks o impor prices. Second, in he presence of a demand shocks he REER decreases, his fac lends suppor o models wih an OLG srucure in which he home currency appreciaes, raher han depreciaes, in boh nominal and real erms in response o a governmen spending shock, as discussed in Shioji, Vu, and Takeuchi (). Table shows he variance decomposiions of inflaion. We can see ha a shor horizons, such as or quarer, mos of he inflaion forecas error variances is explained by demand shocks and especially supply shocks, while he conribuion of moneary shocks is negligible. A long longer horizons moneary shocks become more imporan, bu demand and supply shocks remain o dominae. I is also worh noing ha ha he conribuion demand shocks is sable across differen horizons. This resul migh suppor he view ha demand shocks such as increases in public spending are he main cause of recen inflaion in Vienam. Figure 9 provides he hisorical decomposiions of inflaion in Vienam over he las en years. I is observed ha in he deflaion period - moneary shocks appear o have he larges conribuion. In he period -7 when inflaion became higher, demand shocks and, o a lesser exen, moneary shocks seem o be he main deerminans, while supply shocks seem o work in he favorable direcion o reduce inflaion. In he year 8, when inflaion hi he peak of 3.%, all hree ypes of shocks are imporan deerminans wih supply shocks conribuing slighly more in he second and hird quarers of he year. In he period 8Q-Q3 demand shocks urn negaive which migh reflec he ighened fiscal policy of he governmen o figh inflaion. Moneary shocks are also negaive in he firs hree quarers of he year 9, which is consisen wih he fac ha moneary policy was also ighened in his period. In conras, supply shocks are always posiive in he period 8Q-Q3, making inflaion o be persisen. In he year moneary shocks urn posiive, pushing up inflaion. 7. Concluding Remarks In his paper we use a srucural VAR idenified by sign resricions o analyze he causes of recen inflaion in Vienam. The sign resricions are drawn from a New Keynesian DSGE model which is buil o capure several imporan aspecs of he Vienamese economy and is calibraed o he daa of Vienam. We find ha supply shocks and demand shocks seem o explain a large par of inflaion

13 over he whole sample period, while he conribuion of moneary shocks is smaller bu no negligible. In addiion, demand shocks (ypically governmen spending shocks) and o a lesser exen moneary shocks seem o be he main deerminans of inflaion in he period Q-8Q3, while supply shocks appear o be more imporan in he period 8Q-Q in causing high and persisen inflaion. The resuls sugges ha he Vienamese governmen should pay more aenion o demand facors, especially governmen spending, if i wishes o keep inflaion a a sable and reasonable level. So far we have considered hree ypes of srucural shocks in he VAR. Wih more endogenous variable, i is possible o increase he number of shocks and ge more precisely wha hey are. I is also ineresing o conduc similar sudies for oher Asian counries, which are also facing he inflaion problem, o compare wih he resuls of Vienam. I leave hese asks for fuure work. References Asian Developmen Bank (ADB), Key Indicaors for Asia and he Pacific, available from Bayoumi, Tamim, and Barry Eichengreen (993), Shocking aspecs of European moneary unificaion, NBER Working Paper, No Blanchard, Olivier J., and Danny Quah (989), The dynamic effecs of aggregae demand and supply disurbances, American Economic Review 79, 73. Canova, Fabio (7), Mehods for Applied Macroeconomics Research, Princeon Universiy Press, chaper. Clarida, Richard, and Jordi Gali (99), Sources of Real Exchange Rae Flucuaions: How Imporan Are Nominal Shocks? NBER Working Paper No. 8, February. Devereux, B. Michael, Philip R. Lane, and Juanyi Xu (), Exchange rae and moneary policy in emerging marke economies, The Economic Journal,, 78. Dynare version.., available from G eneral Saisics Office (GSO) websie Obsfeld, M. (98), Floaing Exchange Raes: Experience and Prospecs, Brookings Papers on Economic Aciviy, Schumi-Grohe, Sephanie and Marin Uribe (3), Closing small open economy models, Journal of Inernaional Economics,, 3-8. Shioji, Esuro, Vu Tuan Khai, and Hiroko Takeuchi (9), Shocks and incomplee exchange rae pass-hrough in Japan: Evidence from an open economy DSGE model, paper presened a he Far Eas and Souh Asia Meeing of he Economeric Sociey, Universiy of Tokyo, Augus 9. Shioji, Esuro, Vu Tuan Khai, and Hiroko Takeuchi (9), Fiscal Policy in a New Keynesian Overlapping Generaions Model of a Small Open Economy, The Economic Review, Hiosubashi 3

14 Universiy, Vol., No.. Vu, Tuan Khai (), Curren accoun dynamics in a New Keynesian small economy model, The Journal of he Faculy of Economics, Seikei Universiy, July (forhcoming). Table : Srucure of aggregae demand and exernal deb of Vienam (average of -9) Indicaors (as raio o GDP) Acual daa Values used in simulaion (afer adjusing o be consisen wih he seady sae of he model) privae consumpion..7 governmen consumpion.. gross domesic capial formaion.3 - expors of goods and services..9 impors of goods and services exernal deb Noes: In adjusing he acual daa, invesmen by sae-owned firms, which is a par of gross domesic capial formaion, is added o governmen consumpion using daa from he GSO. In addiion, he shares of expors and impors are revised such ha in he seady sae he home counry is running a rade surplus o pay exacly he deb service. Table : Parameer v alues se for simulaion Descripion Para meer Value subjecive discoun facor β.98 world annum ineres rae weigh of labor disuiliy weigh of money holding in uiliy i W.8% ω l ω m inverse of Frisch labor supply elasiciy φ inverse of ineremporal elasiciy of subsiuion σ parameer on he share of I goods in N goods α. elasiciy of subsiuion wihin I&M goods θ elasiciy of subsiuion wihin X goods θ X ineres rae elasiciy of money demand parameer χ deb elasiciy of risk premium parameer ψ. coefficien on price adjusmen cos for I firms coefficien on price adjusmen cos for M firms (benchmark case) coefficien on price adjusmen cos for X firms seady sae TFP of I firms seady sae TFP of X firms ψ I ψ M ψ X A I A X

15 Table 3: Signs of IRFs o srucural shocks drawn from he heoreical model GDP Price level Real exchange rae SR LR SR LR SR LR Moneary shock (M) Demand shock (Governmen spending shock) ?? I-secor TFP shock Supply Shock X-secor TFP shock Foreign price shock Summar y ?? Noes: The shor run (SR) is defined as =,...,, while he long run (LR) is defined as > 8, where is he number of periods afer he shock occurs. A? means ha he sign is ambiguous and hus is no used as resricion in he VA R. Shaded areas mean ha he signs here are used o impose on he IRFs in he VAR model. Table : Variance decomposiions of inflaion Percen of inflaion forecas error variance s due o Quarer Supply shock Demand shock Moneary shock

16 Figu re : Annual raes of inflaion and growh in Vienam 99-. % 9.%. % 8.% 7.%.%.%.%.%.%.% 3.%.% %.%.%.% CPI inflaion (lef axis) GDP growh rae (righ axis) Sources: ADB (). Figure : Monhly inflaion in Vienam and is neighboring Asian counries M-M 3.%.%.%.%.%.%.% China Indonesia Malaysia Philippines Singapore Thailand Vienam.% Jan May Sep Jan May Sep Jan-7 May-7 Sep-7 Jan-8 May-8 Sep-8 Jan-9 May-9 Sep-9 Jan- May- Sep- -.% Sources: CEIC daabase.

17 Figure 3: Effecs of an increase in money supply in he heoreical model 3 x -3 GDP x -3 Inflaion x - Nominal ineres rae. Nominal exchange rae Real exchange rae. Price level x -3 Consumpion 3 x -3 Labor Nominal wage. Domesic iner. price x - Expor price (Px). Impor price (Pm) x -3 Expor quaniy x -3 Impor quaniy x - Trade accoun. Inermediae oupu ψ M =3 ψ M = ψ M = ψ M = Figure : Effecs of an increase in governmen spending in he heoreical model.8 x -3 GDP 3 x Inflaion x Nominal ineres rae x - Nominal exchange rae x - Real exchange rae x - Price level x - Consumpion x -3 Labor x - Nominal wage x - Domesic iner. price -. x - Expor price (Px) x - Impor price (Pm) x -3 Expor quaniy x -3 Impor quaniy x - Trade accoun 3 x -3 Inermediae oupu ψ M =3 ψ M = ψ M = ψ M = 7

18 Figure : Effecs of an increase in TFP of domesic inermediae secor in he heoreical model x - GDP x - Inflaion 3 x Nominal ineres rae x -3 Nominal exchange rae x -3 Real exchange rae x - Price level. x -3 Consumpion x -3 Labor x -3 Nominal wage Domesic iner. price x - Expor price (Px) x -3 Impor price (Pm) x -3 Expor quaniy x -3 Impor quaniy x - Trade accoun. Inermediae oupu ψ M =3 ψ M = ψ M = ψ M = Figure : Effecs of an increase in TFP of expor secor in he heoreical model x -3 GDP x - Inflaion x Nominal ineres rae - x -3 Nominal exchange rae x -3 Real exchange rae x -3 Price level 7 x -3 Consumpion -3 x -3 Labor x -3 Nominal wage x -3 Domesic iner. price x -3 Expor price (Px) x -3 Impor price (Pm) Expor quaniy. Impor quaniy x - Trade accoun Inermediae oupu ψ M =3 ψ M = ψ M = ψ M = 8

19 Figure 7: Effecs of a decrease in impor price in he heoreical model x -3 GDP x - Inflaion x Nominal ineres rae 8 x -3 Nominal exchange rae - 3 x -3 Real exchange rae x -3 Price level 7 x -3 Consumpion - x -3 Labor x -3 Nominal wage 8 x -3 Domesic iner. price x - Expor price (Px) x -3 Impor price (Pm) x -3 Expor quaniy x -3 Impor quaniy x - Trade accoun Inermediae oupu ψ M =3 ψ M = ψ M = ψ M = 9

20 Figure 8: Responses of GDP, CPI, and REER o supply, demand, and moneary shock in he VAR model x -3 GDP o supply shock CPI o supply shock -. x -3 GDP o demand shock CPI o demand shock x -3 GDP o moneary shock CPI o moneary shock.3 REER o supply shock REER o demand shock x -3 REER o moneary shock Noes: Dashed lines are h and 8 h quaniles, while solid lines are h quaniles. Figure 9: Hisorical decomposiions of srucural shocks o inflaion in Vienam - 7.% 3%.% 3%.% % 3.% %.% %.% % -.% % -3.% % -.% supply shock moneary shock year-on-year inflaion (righ axis) demand shock oal effec of shock %