Abstract
Purpose
This study focuses on analyzing the relation between money supply, inflation and output in Vietnam and China.
Design/methodology/approach
Using the error correction model and the vector autoregression model (ECM and VAR) and the canonical cointegration regression (CCR), the study shows similar patterns of these variable relations between the two economies.
Findings
The study points out the difference in the estimated coefficients between the two countries with different economic scales. While inflation in Vietnam is strongly influenced by expected inflation and output growth, inflation in China is strongly influenced by money supply growth and output growth.
Originality/value
To the best of the authors’ knowledge, this is the first empirical and comparative research on the relation between money supply, inflation and output for Vietnam and China. The study demonstrates that the relationship between money supply, inflation and output is still true in case of transition economies.
Keywords
Citation
Long, P.D., Hien, B.Q. and Ngoc, P.T.B. (2021), "Money supply, inflation and output: an empirically comparative analysis for Vietnam and China", Asian Journal of Economics and Banking, Vol. ahead-of-print No. ahead-of-print. https://doi.org/10.1108/AJEB-03-2021-0040
Publisher
:Emerald Publishing Limited
Copyright © 2021, Pham Dinh Long, Bui Quang Hien and Pham Thi Bich Ngoc
License
Published in Asian Journal of Economics and Banking. Published by Emerald Publishing Limited. This article is published under the Creative Commons Attribution (CC BY 4.0) licence. Anyone may reproduce, distribute, translate and create derivative works of this article (for both commercial and non-commercial purposes), subject to full attribution to the original publication and authors. The full terms of this licence may be seen at http://creativecommons.org/licences/by/4.0/legalcode
1. Introduction
During economic transition, China has been considered a leader among socialist countries that have successfully transformed the economic model from a planned economy to a market-oriented economy. Economic reform is urgent and under pressure when the economy suffers serious crises. This reform is similar in Vietnam, but Vietnamese reform is 10 years later than Chinese one (1978 in China, 1986 in Vietnam) (Ma, 1999; Dao and Vu, 2008). It can be said that economic reform in China has provided some experience and creates motivation for many countries to conduct similar transitions. However, China and Vietnam are the only two countries that have been transformed from a planned economy to a market-oriented economy while keeping their own orientations. In the 1980s, apart from changing the political system, the Soviet Union and Eastern European countries have shifted to the market economy. In the area of monetary policy, China and Vietnam also have a thorough transition from one-tier bank system – which holds full control of the national financial system to two-tier bank system – by splitting into central banks and commercial banks, providing credit services for specific industries (Ma, 1999; Oanh, 2001; Dao and Vu, 2008). This change helps the instruments of monetary policy be activated and gradually take effect. Monetary turmoil phenomena created by mixed economies (systems including a planned economy and a market economy at the same time) have narrowed. Inflation is lowered and controlled to be more stable than before reform. Capital markets were formed after nearly a decade of economic reform (1990 in China, 2000 in Vietnam). On the other hand, Vietnam's accession to the World Trade Organization is 6 years later than China (China in 2001, Vietnam in 2007). These show that China always implements important steps in reform and achieves results before Vietnam.
There are similarities as well as differences in the economy between Vietnam and China (Duong and Le, 2007). Both countries pursue the market-oriented economy, the same pattern of economic reform, development and integration process. Particularly, Vietnam follows the socialist-oriented market economy. China follows a “socialist market economy with Chinese characteristics. The political systems of two countries have certain similarities. Similarities may come from the success of China's economic reform policies, and these policies are always ahead of Vietnam (Ma, 1999; Dao and Vu, 2008). Moreover, in terms of economics, if a country accepts and operates under a market mechanism, relations in that economy will also have to follow the rules of the market. This leads to similarities in results. However, the size of two economies is different. The capacity of influence on economics and politics is also different (Duong and Le, 2007; VNEP, 2016). Furthermore, in terms of geography and history, China is less influenced by political and economic changes in the world than Vietnam. In fact, China is an important element which contributes to the establishment of international relations in general and in the economic field in particular. In the opposite direction, Vietnam is strongly affected by these relations.
In the quantity theory of money (QTM), the relation between money stock (M) and price level (P) can be expressed through the equation
This study focuses on analyzing the relation of three macro-variables, including money supply real output and price level. Although this issue seems to be simple and obvious, previous studies about it are only conducted in other countries and China but not Vietnam (Chow and Shen, 2005; Aksoy and Piskorski, 2006; Budina et al., 2006; Homaifar and Zhang, 2008; Haug and Dewald, 2010; Anh and Thuy, 2013; Truong, 2013). In addition, limited data can be a reason why empirical research on this issue has not performed in Vietnam in previous studies. What is the relation between these three variables when two countries have many similarities in terms of economics and politics but have different economic scales? This paper will examine the relationship between money supply, inflation and output in Vietnam during the period 1986–2016 and in China during the period 1978–2008. After 30 years of reform, the study aims to demonstrate the existence of the relation between these variables and expect a new finding when using new quantitative techniques in time series data processing. Accordingly, the study contributes to shed light on the interaction between variables mentioned in the area of monetary policy management.
The paper is organized as follows. Section 1 highlights briefly the achievement of economic reform as well as the similarities and differences in the economy between Vietnam and China. This section also mentions the QTM,
2. Methodology
2.1 Research model
Based on the equation
2.2 Data research
In Vietnam, data are collected from 1986 to 2016 from the World Bank (WB), the International Monetary Fund (IMF), the State Bank of Vietnam (SBV) and Asset Macro in the UK (http://assetmacro.com). GDP and consumer price index (CPI) are chosen as variables representing the output variable (symbol Y) and the price variable (symbol P). GDP is collected directly from World Development Indicators (WDI) of WB with the original price in the base year 2010. The CPI is taken from the IMF with the comparative price of 2010 for the period 1995–2016. For the period 1986–1994, the CPI is collected from the IMF with the comparative price of 2005 and transferred to the original price of 2010 by applying the author's formula (3). Y and M2 variables are valued variables. The CPI variable is in percentage form. M2 money supply is collected from the IMF, SBV and Asset Macro with comparison.
In China, variables including M2 money supply, the retail price index and GDP are used to represent money supply M2, price level P and output Y. The data are derived from the study of Chow and Shen (2005) for the period 1952–2002 and from China Statistical Yearbook of the National Bureau of Statistics (NBS) of China for the period 2003–2008. The data for the period 1952–2002 are taken from the NBS, but estimates are similar to the methods that the author used when the data are not directly available (see data description of Chow and Shen (2005)).
3. Empirical result
3.1 Unit root test and Johansen cointegration test
The study uses unit root test to test the stationary of variables, for the case of Vietnam (1986–2016) and China (1978–2008). At the first difference, results show that the null hypothesis of a unit root for all variables considered can be rejected. This means that variables stop at the first difference (Table 1). After testing for stationary, Johansen cointegration test is conducted. A value of 1% (or 5%) is greater than the value of trace statistics for both Vietnam and China (Tables 2 and 3). Results indicate that there exists a long-term relationship between variables
3.2 Volatility of price level and inflation
The equation
OLS regression results which show the impact of M2/Y on the level price P are presented in equations (3) and (4), respectively, for Vietnam in the period 1986–2016 and for China in the period 1978–2008 after 30 years of reform (Table 4). The estimated coefficients show no big significant difference between the period 1952–2002 and the period 1978–2008. Specifically, the elasticity of log (P2) is 0.374 in the period 1952–2002 (Chow and Shen, 2005) and 0.418 in the period 1978–2008. In Vietnam, the elasticity (0.630) of log (M2/P) against log (P) is larger than that of China but not so different. Lag 1 of the residuals of the corresponding OLS model is saved as an independent variable. This variable is used to represent the adjustment coefficient in the ECM-VAR for the inflation estimation model
3.3 Money supply, inflation and output
The relation between money supply, inflation and output are regressed by the ECM-VAR model. Tables 6 and 7 show the comparison of regression results for money supply, inflation and output in Vietnam during the period 1986–2016 and in China during the period 1978–2008 after 30 years of reform and the period 1952–2002 according to the research of Chow and Shen (2005). The results of the ECM-VAR model show that there is a downside when some important impacts are not statistically significant, and expected signs are different from expectation. For example, the impact of money supply on growth is not statistically significant for both Vietnam and China. Money supply and growth which have negative impacts on inflation are statistically significant at 5 and 10%, respectively in the case of Vietnam. Results of the autocorrelation test and the normality test of residuals are violated in some cases. In Vietnam, there is an autocorrelation phenomenon when considering LM(2) at a significance level of 5%. The residuals are not normally distributed when
In terms of inflation, all variables, including M2 money supply growth, inflation and output growth, in the previous year influence inflation in the current year in both cases of Vietnam and China. First, the regression results show that inflation in Vietnam is strongly affected by inflation in the previous year. If inflation in the previous year is on an upward trend, it is likely that inflation in the following year will increase. On the other hand, due to a time lag in monetary policy implementation, inflation is difficult to control and may reverse in the next year. For the Chinese economy, last year's inflation also affects inflation in the current year, but this effect is weaker than that in Vietnam (0.180 < 0.381). This suggests that using the lagged value of inflation as expected inflation is inadequate since the estimated coefficient of Vietnam is almost two times higher than that of China. Second, output growth in the previous year increases pressure on inflation in the current year. This effect can be explained by the aggregate supply-aggregate demand model (AS-AD). When the economy has not reached potential output, an increase in the level of output will lead to an increase in the price level. The impact factor of output growth on inflation in Vietnam is approximately two times smaller than that of China (0.332 < 0.657). This implies that growth in Vietnam just partly influences inflation. Meanwhile, growth seems to have a huge impact on inflation in China. Third, a rise in M2 money supply growth in the previous year exerts upward pressure on the current year's inflation. In the money market, an increase in money supply will lead to a decrease in the base rate. Reduced interest rate helps stimulate investment and contribute to a rise in the aggregate demand. In the AS-AD model, an increase in the aggregate demand results in an increase in the price leve,l which in turn raises inflation. Moreover, this is consistent with Friedman's finding in which inflation is a monetary phenomenon that happens when the quantity of money increases more rapidly than output (Friedman, 1970). There is a difference in the regression results for Vietnam and China. In Vietnam, the effect of
In terms of output, output growth is positively affected by M2 money supply growth and output growth in the previous year and is negatively affected by last year's inflation. First, results show that increasing money supply to stimulate investment and boost growth in Vietnam is less effective than in China (0.0296 > 0.378). This implies that the quantity of money injected into the economy to use for investment growth is restricted, or investment efficiency is not high. Second, the negative impact of inflation and the positive impact of M2 money supply growth in the previous year are very small in the case of Vietnam. Meanwhile, the regression results for China show that the signs of these two estimated coefficients are similar to those for Vietnam, but the impact is high. Previous studies suggest that inflation has a negative impact on growth (Ghosh and Phillips, 1998; Dammak and Helali, 2017). In Vietnam, the elasticity of expected inflation on output growth is low. According to the regression results, this may be due to the strong impact of the expected output growth (0.533) and the impact of other factors other than money supply and inflation. Third, there is a similarity in the impact factor of the expected output growth on output growth for both Vietnam (0.533) and China (0.537).
4. Conclusion
After 30 years of reform, both Vietnam and China have made a successful revolution from a planned economy to a market economy, creating tremendous economic development. Through empirical evidence, the study demonstrates that the relationship between money supply, inflation and output is still true in the case of transition economies. The law of the market is correct, though the orientation of certain market economies is different from that of developed countries with a long-standing market economy. In addition, the study shows that the degree of the interaction between money supply, inflation and output varies responding to particular conditions of two countries, in which both pursue a market-oriented mechanism but differ in the scale of the economy.
Figures
Results of unit root test
Variable | Vietnam (1986–2006) | China (1978–2008) | ||
---|---|---|---|---|
Zero difference | First difference | Zero difference | First difference | |
log(Y) | −1.394 | −3.459*5 | 0.840 | −5.889*1 |
log(P) | −2.727*10 | −9.669*1 | −0.377 | −4.332*1 |
log(M2) | −1.248 | −7.746*1 | 0.605 | −2.683*10 |
Note(s): *1, *5, and *10 denote the significance at the 1%, 5%, and 10% levels, respectively
Results of Johansen cointegration test for
The number of cointegrating relations | Eigenvalue | Trace statistics | 5 Percent | 1 Percent |
---|---|---|---|---|
Critical value | Critical value | |||
0 | – | 80.76 | 29.68 | 35.65 |
1 | 0.88 | 19.13*1 | 15.41 | 20.04 |
2 | 0.36 | 6.24*5 | 3.76 | 6.65 |
Note(s): *1 and *5denote the significance at the 1% and 5% levels, respectively
Results from Johansen cointegration test for
The number of cointegrating relations | Eigenvalue | Trace statistic | 5 Percent | 1 Percent |
---|---|---|---|---|
Critical value | Critical value | |||
0 | – | 48.63 | 34.91 | 41.07 |
1 | 0.56 | 23.34*1 | 19.96 | 24.60 |
2 | 0.37 | 8.86*5 | 9.42 | 12.97 |
Note(s): *1 and *5denote the significance at the 1% and 5% levels, respectively
OLS model for the price level for Vietnam and China
Variable | Vietnam (1986–2016) | China (1978–2008) | China (1952–2002) |
---|---|---|---|
0.630*1 | 0.418*1 | 0.374*1 | |
Constant | 4.831*1 | −0.934*1 | −0.713*1 |
Number of Observations | 31 | 31 | 51 |
R squared | 0.913 | 0.966 | 0.965 |
Note(s): *1 denote the significance at the 1% level
Error correction model for inflation in the case of Vietnam and China
Variable | Vietnam (1986–2016) | China (1978–2008) | China (1952–2002) |
---|---|---|---|
0.617*1 | 0.216*10 | 0.160*1 | |
0.439*5 | 0.656*1 | 0.558*1 | |
−0.225 | −0.0629 | −0.0307 | |
−0.0732 | −0.223*1 | −0.169*1 | |
Constant | −0.0145 | −0.00123 | 0.000951 |
Number of observations | 29 | 31 | 49 |
R squared | 0.880 | 0.643 | 0.658 |
Note(s): *1, *5 and *10 denote the significance at the 1%, 5% and 10% levels, respectively
Error correction model of
Variable | Error correction model following VAR structure | |||||
---|---|---|---|---|---|---|
Vietnam (1986–2016) | China (1952–2002) | |||||
ECT(−1) | −0.279*1 | 0.0103 | −0.304*1 | −0.16*1 | −0.239 | −0.0706 |
0.350*5 | 0.0237 | 0.111 | 0.542*1 | 0.0599 | 0.221 | |
−1.926*10 | 0.0597 | −2.875*1 | 0.137*10 | 0.458*1 | 0.526*1 | |
−0.335*5 | −0.00123 | −0.127 | 0.110*10 | −0.175 | 0.429*1 | |
Constant | −0.0790 | 0.0721*1 | 0.0748 | −0.04*1 | 0.0206 | 0.0326 |
Number of observations | 29 | 29 | 29 | 49 | 49 | 49 |
N(1) | 0.016 | 0.572 | 0.669 | 0.000 | 0.000 | 0.340 |
LM(1) | 0.544 | 0.031 | ||||
LM(2) | 0.095 | 0.172 | ||||
LM(3) | 0.794 | 0.185 |
Note(s): LM (lag): the Lagrange Multiplier test where the null hypothesis is that there is no autocorrelation between variables. N (1): the Jarque-Bera test for normality of the residuals where the hypothesis H0 is that the residuals are normally distributed. *1, *5, and *10 denote the significance at the 1%, 5%, and 10% levels, respectively
Error correction model of
Variable | ECM following VAR | |||||
---|---|---|---|---|---|---|
Vietnam (1986–2016) | China (1978–2008) | |||||
ECT(−1) | −0.279*1 | 0.0103 | −0.304*1 | −0.0516 | −0.0180 | −0.140*1 |
0.350*5 | 0.0237 | 0.111 | 0.464*1 | −0.181*10 | 0.113 | |
−1.926*10 | 0.0597 | −2.875*1 | 0.857*1 | 0.463*1 | 0.373 | |
−0.335*5 | −0.00123 | −0.127 | 0.170 | 0.0208 | 0.374*1 | |
Constant | −0.0790 | 0.0721*1 | 0.0748 | −0.12*1 | 0.0473*5 | 0.0363 |
Number of observations | 29 | 29 | 29 | 31 | 31 | 31 |
N(1) | 0.016 | 0.572 | 0.669 | 0.445 | 0.731 | 0.525 |
LM(1) | 0.544 | 0.68 | ||||
LM(2) | 0.095 | 0.24 | ||||
LM(3) | 0.794 | 0.833 |
Note(s): LM (lag): the Lagrange Multiplier test where the null hypothesis is that there is no autocorrelation between variables. N (1): the Jarque-Bera test for normality of the residuals where the hypothesis H0 is that the residuals are normally distributed. *1, *5, and *10 denote the significance at the 1%, 5%, and 10% levels, respectively
Canonical cointegration regression model of
Variable | CCR model | |||||
---|---|---|---|---|---|---|
Vietnam (1986–2016) | China (1978–2008) | |||||
0.38*1 | −0.0097*5 | 0.0192 | 0.180*5 | −0.317*1 | −0.474*5 | |
0.332*10 | 0.533*1 | 0.497*5 | 0.657*1 | 0.537*1 | 1.387*1 | |
0.14*1 | 0.0296*1 | 0.507*1 | 0.330*1 | 0.378*1 | 0.601*1 | |
Constant | −0.0106 | 0.023*1 | 0.085*1 | −0.08*1 | −0.0484*5 | 0.0589 |
Linear | – | – | – | −0.0009*10 | 0.0014*1 | −0.005*1 |
Number of observations | 28 | 28 | 28 | 30 | 30 | 30 |
R squared | 0.746 | 0.145 | 0.713 | 0.457 | 0.554 | 0.554 |
Note(s): *1, *5, and *10 denote the significance at the 1%, 5%, and 10% levels, respectively
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Further reading
Chow, G.C. (1987), “Money and price level determination in China”, Journal of Comparative Economics, Vol. 11, pp. 319-333.
Knell, M. and Stix, H. (2005), “The income elasticity of money demand: a meta-analysis of empirical results”, Journal of Economic Surveys, Vol. 19, pp. 513-533, doi: 10.1111/j.0950-0804.2005.00257.x.
Kumar, S. (2014), “Money demand income elasticity in advanced and developing countries: new evidence from meta-analysis”, Applied Economics, Vol. 46, pp. 1873-1882, doi: 10.1080/00036846.2014.887195.
Sriram (1999), Survey of Literature on Demand for Money: Theoretical and Empirical Work with Special Reference to Error-Correction Models, Work Pap No. 99/64, IMF, pp. 1-77.
Zuo, H. and Park, S.Y. (2011), “Money demand in China and time-varying cointegration”, China Economic Review, Vol. 22, pp. 330-343, doi: 10.1016/j.chieco.2011.04.001.
Acknowledgements
Funding: This research is funded by Vietnam National Foundation for Science and Technology Development (NAFODSTED) under grant number 502.01-2018.316.