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ABSTRACT
In case of small open economy, the conduct of monetary policy has faced obstacles to achieve primary goals of price stability, due to high vulnerability to external shocks and weak policy frameworks. Therefore, this paper aims to analyse the effectiveness of monetary policy transmission channels in restraining inflation in case of Vietnam for 2001-2015. The use of a Vector Error Correction Model yields evidence that credit growth is the key determinant of high inflation. Additionally, the results suggest the interest rate channel has a perverse effect on inflation in the long run, which means that the inflation rate increases with the policy rate. There is also significant short-run causal relationship from credit growth to inflation, and from the policy rate to inflation. However, empirical results fail to confirm the existence of relationship between the exchange rate channel and inflation in both short run and long run.
Disclosure statement
No potential conflict of interest was reported by the author.
Notes
1. During normal periods of economic growth, large budget deficit would constrain increase in government spending to promote aggregate demand. In Vietnam, government budget deficit (as percentage of GDP) has increased sharply from only an average of 1.3% in the 2003–2007 period to 3.7% in the 2009–2011 period, becoming the country with the highest state's budget deficit in ASEAN (ADB Citation2014).
2. The liquidity effect raised by Friedman (Citation1969) refers to the ceteris paribus downward trend in interest rate caused by rise in money supply.
3. As Mundell (Citation1963) and Fleming (Citation1962)'s open economy IS/LM, OMOs (e.g. buying domestic bonds) will be conducted by central bank to offset capital inflow to defend fixed exchange rate.
4. The ratio of deposits and loans to GDP is increasingly high overtime (both reaching over 90% after 2008) while that of total domestic currency bonds and corporation bonds are modest (accounting for less than 20% of GDP), reported by World Bank Statistics.
5. The units of domestic currency per US dollar (VND per USD).
6. According to Enders (Citation2010), the maximum lag length can be chosen by the frequency of the data. Monthly data can have a maximum lag length of 12.
7. Most empirical studies give a comment that the interest rate channel has only a trivial impact on Vietnam's inflation movements.
Additional information
Notes on contributors
Ngan Tran
Ngan Tran is a lecturer at Department of Banking, Banking Academy, Hanoi, Vietnam. She is currently a PhD candidate at School of Economics, Finance and Marketing at RMIT University, Melbourne, Australia. Her research area is applied econometrics and macroeconometrics.