Monetary transmission mechanism analysis in a small, open economy: the case of Vietnam

The transmission mechanism of monetary policy describes the dynamic stages in which a central bank’s monetary policies are transmitted to real output and prices. It plays a crucial, perhaps even central, role in the study of monetary economics. However, few studies have focussed on developing small, open economies, and even fewer have covered characteristics such as the aggregate demand components, the low independence of monetary policy, the weak developing financial markets and structural changes in the economy. Few quantitative empirical studies have been conducted on the monetary transmission mechanism in Vietnam, and they do not include a non-recursive structural vector autoregression model with structural breaks, and characteristics of a small, open economy. This study attempts to fill such research gaps. The aim of this thesis is examining the role of monetary policy in the Vietnamese economy, in terms of shocks to the economy via different channels, and the international dimension of the monetary transmission mechanism in the small, open economy of Vietnam. To answer these questions, the study uses quarterly data for the period 2000:1 to 2011:4 and the Structural Vector Autoregression (SVAR) approach. The SVAR is more suited than the Vector Autoregression (VAR) approach to examining structural shocks as a test of multivariate models. The findings show that the statistically significant break dates are found in this study, so a dummy variable is included in the SVAR model of Vietnam. The study’s findings reveal that the impacts of a monetary contraction on domestic variables are largely consistent with theories, except for its impact on price level. A monetary contraction causes the output to decrease, but weak. The monetary channels explain about 20 percent of fluctuations in real output. The higher output causes the domestic price to increase. A money shock is not a main reason in increasing the domestic price because of its small and statistically insignificant effects. Vietnam’s current price-controlling regimes are effective in ensuring price stability in spite of shocks in world oil and rice prices. The outcomes of this research illustrate that the interest rate channel is the most effective channel for transmission to price fluctuations and the exchange rate for output variations. The study found the stock price channel as the least effective, which is consistent with the modest role of the stock market in the Vietnamese economy. This limits the statistically significant contemporaneous effects of monetary policy (the interest rate and credit) on stock prices. The monetary aggregate could not be a reliable tool to contemporaneously transmit monetary policy signals to the financial market.