Effects of trend inflation on monetary policy and fiscal policy shocks in Vietnam

Thanh Ha Le,Nigel Finch

doi:10.1108/jed-04-2021-0052

Abstract

PurposeThis paper analyzes variations in the effects of monetary and fiscal shocks on responses of macroeconomic variables, determinacy region, and welfare costs due to changes in trend inflation.Design/methodology/approachThe authors develop the New-Keynesian model, in which the central banks can employ either nominal interest rate (IR rule) or money supply (MS rule) to conduct monetary policies. They also use their capital and recurrent spending budgets to conduct fiscal policies. By using the simulated method of moment (SMM) for parameter estimation, the authors characterize Vietnam's economy during 1996Q1–2015Q1.FindingsThe results report that consequences of monetary policy and fiscal policy shocks become more serious if there is a rise in trend inflation. Furthermore, the money supply might not be an effective instrument, and using the government budget for recurrent spending produces severe consequences in the high-trend inflation economy.Practical implicationsThis paper's findings are critical for economists and monetary and fiscal authorities in effectively designing both the monetary and fiscal policies in confronting the shift in the inflation targets.Originality/valueThis is the first paper that examines the effects of trend inflation on the monetary and fiscal policy implementation in the case of Vietnam.

Highlights

Lessons from previous crises have shown three weaknesses in policy implementations of the State Bank of Vietnam (SBV)
We assumed that the monetary authorities employ two instruments: nominal interest rate and money supply to conduct the policies
The main purpose of this article is to investigate the impacts of trend inflation on the consequences of policy shocks in Vietnam

Summary

Introduction

Lessons from previous crises have shown three weaknesses in policy implementations of the State Bank of Vietnam (SBV). SBV has always pursued the objective of stabilizing currency value, curbing inflation and contributing to economic development, which was too widely targeted and lack of specification. The policy implementation in Vietnam, which was a combination of the monetary and fiscal policies has still been inappropriate in the sense that it was used excessively, it reacted and became policy shocks. The SBV lacked a commitment to consistently pursue a fixed inflation target. The Vietnamese economy was simultaneously buffeted by inefficient implementations of monetary and fiscal policies as well as time-varying trend inflation

Objectives

Methods

Conclusion