The relationship between inflation and unemployment in viet nam an ardl bounds testing approach

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THAI NGUYEN UNIVERSITY
UNIVERSITY OF AGRICULTURE AND FORESTRY

JOHN HENRY LACAMPUEÑGA PAPA
THE RELATIONSHIP BETWEEN INFLATION AND UNEMPLOYMENT IN
VIET NAM: AN ARDL BOUNDS TESTING APPROACH

BACHELOR THESIS

Study Mode: Full-time
Major: Agricultural Economics
Faculty: Advanced Education Program Office
Batch: 2018 – 2021

Thai Nguyen, 11/01/2022

Thai Nguyen University of Agriculture and Forestry
Degree Program

Student name
Student ID

Thesis Title

Bachelor of Agricultural Economics

John Henry Lacampueñga Papa
DTN1854250005

The Relationship Between Inflation and Unemployment in

Viet Nam: An ARDL Bounds Testing Approach

Supervisor (s)

Dr. Nguyen Thi Lan Anh

Supervisor’s Signature

1

Abstract:
Inflation and unemployment are two of the most serious economic issues. In order
to establish the necessary policies to combat these issues, it is vital to comprehend
their relationship. The main objective of this study is to investigate the
relationship between inflation and unemployment in Viet Nam. The researcher
employed

the

Autoregressive

Distributed

Lag

(ARDL)

model

as

a

methodological framework for determining the co-integration relationship
between the variables. The period of observation was from year 1991 to year
2020. Annual data for inflation and unemployment were gathered for this study.
Using the ARDL Model, the researcher was able to identify a co-integration
relationship between the two variable when inflation is considered as the
dependent variable. Moreover, the estimation also showed the negative and
insignificant of the relationship both in the short-run and in the long-run.

Keywords:

Inflation, Unemployment, ARDL Model, Viet Nam

Number of pages: 49 Pages
Date of
Submission:

11/01/2022

2

ACKNOWLEDGEMENT
This work would not have been possible without the presence, efforts, support, and
prayers of my family and good friends, who motivated me to think and finish this
research.
First and foremost, I would like to thank God for showering His blessings on me

throughout this research, for allowing me to successfully complete the research, and for
letting me get through all the difficulties. I have experienced your guidance day by day.
Thank you for listening to all my prayers and for guiding me throughout this journey.
I would like to express my deepest gratitude to my family (Mr. Telesforo C. Papa II,
Mrs. Rocel L. Papa, and Gabriel Oliver L. Papa) for the sacrifices that they have
made for educating me and for preparing me for my future. I am forever grateful for the
love, support, and understanding that you’ve given me throughout my college life. You
all served as my motivation to finish this thesis.
I would like to acknowledge and give my warmest thanks to my supervisor (Dr. Nguyen
Lan Anh) who made this work possible. Your guidance and advice carried me through
all the stages of writing this thesis.
I would like give thanks to my girlfriend (Angelica Millete S. Adriano) who helped me
a lot in this thesis. Thank you for all the efforts that you have exerted and for staying up
all night with me to finish my thesis. All our hard work and efforts will pay off soon.
I would like to give thanks to my Elibap for being my stress reliever and for giving me
a reason to be happy every day.

3

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I would also like to thank all my friends (James, Raphael, Isaiah, JC, Ðức, Ronnieca,
Hanna, Elisha, Jemimah, and Stefanie) for making my life here in Vietnam much
easier and for being a family to me. Thank you all for the love, care, and support that
you’ve given me.
For all the people who believed in me, who stayed by my side, who I shared memorable
moments with, and who taught me valuable lessons in life, a big thanks to all of you.
John Henry Lacampueñga Papa

Definition......................................................................................................... 12

PART II. LITERATURE REVIEW ............................................................................. 14
2.1.

Inflation ........................................................................................................... 14

2.2.

Unemployment ............................................................................................... 19

2.3.

Relationship Between Inflation and Unemployment .................................. 20

PART III. METHODS .................................................................................................... 25
3.1.

Data ................................................................................................................. 25

3.2.

Model Specification ........................................................................................ 25

3.3.

Pre-estimation Test ........................................................................................ 27

3.3.1. Augmented Dickey Fuller Test ..................................................................... 27
3.3.2. Optimal Lag Length Determination ............................................................ 28

3.4.

Co-integration Test ........................................................................................ 28

3.5.

Diagnostics ...................................................................................................... 28

3.5.1. Autocorrelation Test ...................................................................................... 28
3.5.2. Heteroscedasticity Test .................................................................................. 29
3.5.3. Normality Test ................................................................................................ 29
3.5.4. Parameter Stability Test................................................................................ 29
PART IV. RESULTS....................................................................................................... 30
4.1.

Graphical Presentation .................................................................................. 30

4.2.

Optimal lag length Selection ......................................................................... 30

4.3.

Stationarity Test Using Augmented Dickey Fuller Unit Root Test ........... 31

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Discussion........................................................................................................ 41

5.2.

Conclusion ...................................................................................................... 42

REFERENCES................................................................................................................. 43
APPENDIX ....................................................................................................................... 49

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LIST OF FIGURES
Figure 1. CPI Composition as of 2008
Figure 2. Philips Curve
Figuer 3. Graphical Presentation of the Inflation and Unemployment
Figure 4. Cumulative Sum (CUSUM) Stability Test

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LIST OF TABLES

Table 1. Optimal Lag Length Selection
Table 2. Augmented Dickey Fuller (ADF) Unit Root Test
Table 3. Autoregressive Distributed Lag (ARDL) Model (1991-2020)
Table 4. ARDL Bounds Test Result
Table 5. Error Correction Model
Table 6. Breusch-Godfrey Serial Correlation LM Test
Table 7. Breusch-Pagan Test for Heteroscedasticity
Table 8. Jarque-Bera Normality Test

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LIST OF ABBREVIATIONS
ARDL – Autoregressive Distributed Lag Model
AIC – Akaike Information Criterion
ADF – Augmented Dickey Fuller
CUSUM – Cumulative Sum

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PART 1. INTRODUCTION

1.1.

Research Rationale

Inflation and unemployment are two major issues that need to be addressed when it
comes to economic strategies. Countries would not be able to eliminate both
unemployment and inflation at the same time due to the inverse link between the two.
In macroeconomics, the Phillips Curve concept investigates this inverse relationship.
Inflation is the decrease in the buying power of a given currency over time. The increase
in the general price level actively demonstrates that a certain currency buys less than it
did in the previous times (Fernando, 2020). Inflation is a phenomenon that is universal.
It is also a significant predictor of well-being (Tella et al, 2001; Duasa & Nursilah,
2009).
One of the major problems concerning inflation is that when it gets higher, it causes a
regressive effect on lower-income households who may be working on a fixed income.
If the price of goods and services rise higher than wages, there would be a sharp
reduction in real earnings.
Compared with the previous year, Vietnam recoded a 2.8% average inflation rate in
2019. Inflation in Vietnam appears to have stabilized after a stunning dip below 1% in
2015, and is expected to settle at approximately 4% in the coming years.
A scenario in which a person of working age is unable to find work but want to work
full-time is described as unemployment (Pettinger, 2019). Unemployment arises when
a person is willing to work and wishes to work but is unable to find decent occupations.

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With more unemployed workers, overall economic output would be smaller than it
would be otherwise (Hayes, 2021).
According to General Statistics Office of Vietnam, the unemployment in Vietnam
dropped from 2.50 percent in the third quarter of 2020 to 2.37 percent in the fourth
quarter of 2020.
Monetary policymakers have long debated the relationship between inflation and
unemployment, which relates inflation to economic gap metrics like unemployment (Liu
& Rudebusch, 2010). The link between unemployment and inflation, according to many
economists, is a crucial aspect of monetary policy (Liu & Rudebusch, 2010).
Unemployment and inflation are a trade-off problem, with one being employed at the
expense of the other, making it difficult to effectively solve poverty, crime, pollution,
and other domestic issues (Holt et al, 1971).
1.2.

Research Objective

General Objectives: The objective of this study is to investigate any existent relationship
between unemployment and inflation in Vietnam.
Specific Objectives:
• To identify if inflation and unemployment are co-integrated.
• To identify if inflation and unemployment has a significant relationship.
1.3.

Research Questions and Hypothesis

Is there a significant relationship between inflation and unemployment in Vietnam?

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Ho – There is no co-integration relationship between inflation and unemployment in
Vietnam
Ha - There is a co-integration relationship between inflation and unemployment in
Vietnam
1.4.

Limitations

The scope of the data used in this study is from year 1991 up to year 2020. Lack of data
availability is one of the limitations of this study. Annual data for inflation and
unemployment was used since monthly and quarterly data are not available. The study
focuses on identifying if co-integration exists and if there is a significant relationship
between inflation and unemployment in Vietnam.
1.5.

Definition

Inflation - an increase in prices and a decrease in the purchasing power of money.
Inflation Rate - the rate at which a currency's value declines and, as a result, the general
level of prices for goods and services rises.
Unemployment – occurs when people are out of job and actively looking for work.
Unemployment Rate - the percentage of the workforce that is unemployed.
Time Series Data Analysis - a method of studying a collection of data points over a
period of time.
Co-integration Test - a test used to determine if a long-term correlation is present

between many time series.

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Unit Root Test - a test for stationarity in a time series. It determines whether the time
series data is stationary or non-stationary.

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PART II. LITERATURE REVIEW
2.1.

Inflation

Inflation is a measure of change in an economy's overall price level. Economic outcomes
are a significant determinant of asset values because they affect market players'
expectations. Inflation has been considered as “the bane of central bankers” (Bernanke,
2002). The rule of law, the strength of organizations, environment and infrastructure,
taxation, efficacy, and incentive structure, and the welfare state are all important
structural variables, but inflation is a significant focus of cyclical policy.

The two types of inflation, namely deflation and hyperinflation are both likely to cause
disastrous outcomes. It can be difficult to recover from deflation once it has set in, which
usually occurs as a consequence of a drop in total demand. Periods of debt deflation
occur, when prices and economic activity collapse, placing escalating actual debt loads
in jeopardy. (Fisher, 1933), (Bernanke, 2002). Inflationary periods are associated with
poor economic outcomes and tend to last. During periods of hyperinflation money
creation to fuel government expenditure is generally carried to extreme heights, which
is frequently referred to as period inflation of more than 50% (Cagan, 1956). Paper
assets depreciate quickly, and governments produce banknotes with ever-larger
denominations during periods of hyperinflation. According to Cagan (1956),
hyperinflation is driven by two forces. The first one is the method of monetizing a
shortage. Second one is the individuals' inflation forecasts fluctuate, causing a
momentum component.
Shifting from a time of predictable and steady inflation rate to becoming unpredictable
which generates uncertainty in the economy and may erode trust in nominal assets. In

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economies that aren't designed to deal with high and unpredictable inflation, this
uncertainty contributes to poor economic performance (Fischer et. Al., 2002), (Cagan,
1956), (Fischer & Modigliani, 1978). It is extremely difficult for countries to avoid times
of high and fluctuating inflation.
It is indeed a complex task to appoint indices and there are various ways to intricately
measure inflation. Here are some of the most used ways to measure inflation:
2.1.1. Consumer Price Index (CPI)

The CPI is an indicator of a shift in prices of goods and services purchased by consumers
(ILO, et al., 2020). The most commonly employed inflation indicators are the CPI and
its variants. The methodology for calculating CPIs, on the other hand, varied from nation
to country.
It is said that recalling the CPI’s critics throughout the years is definitely important.
Changes in the price of the products is not the only factor that is being monitored by the
index, it also considers the alterations in the living cost. Additionally, diversity of
customers is also considered, since an average consumer can only be represented by a
single pricing index. Every year, according to Moulton & Moses (1997), the CPI is off
by more than 1% in the United States. This is primarily to an inability to effectively take
into consideration the advancements in product quality and consumers' changing desires
as a result of changes in price.

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Figure 1. CPI Composition as of 2008
2.1.2. Producer Price Index (PPI)
The producer's rate of change in the prices of products and services purchased and sold
is measured by producer price indices (ILO, IMF, OECD, UNECE & World Bank,
2004). The PPI, like the CPI, is a collection of pricing indices based on principles
established by the ILO, IMF, OECD, UNECE, and World Bank. It's worth mentioning
that the notion of the PPI predates the Wholesale Price Index, which tracks the rate of
change in wholesale goods prices. Although the United States switched from the latter
to the former in 1978, it is still used in other nations such as India and the Philippines.
As according conventional wisdom, PPI fluctuations foreshadow the changes in CPI, as

a result of higher pricing being passed on to the customer later. Although the conversion
of PPI to CPI has been extensively researched, there’s still no broad consensus on

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whether the two have a one-way causal link. When looking into the reasons of inflation,
we go over the literature on the subject.
2.1.3. GDP Deflator
GDP deflators are a different type of inflation measure. In its most basic form, a GDP
deflator is described as the ratio of nominal GDP to real GDP. The primary distinction
between this metric and all the others so far, the only difference is that it isn't based on
a basket of products and services. It's worth noting that a GDP deflator, which is
calculated using real GDP, appears to suffer from the similar issues. A price
phenomenon may include improved terms of trade for instance (Kohli, 2004).
Identifying the roots of inflation is as old as the practice of estimating inflation. Vaughan
(1675) attempted to separate inflation induced by currency depreciation from inflation
produced by gold inflow. Divergence between cost-push and demand-driven inflation
can be traced back to the late 18th century 'Bullionist Controversy' (Laidlier, 2000). Wai
(1959) made another distinction, in which he separates inflation that is driven by
investments from inflation that is driven by consumer and proclaims to have less danger
and long-lasting.
It is widely agreed that anticipating inflation, whether voluntarily or as a result of builtin inflation-adjustment mechanisms, is a source of inflation (Carvalho, et al., 2017). For
example, (Nishizaki, et al., 2012) mention falling inflation expectations being one of the
causes of deflation in Japan, as discussed in the part on the incidence of nearhyperinflation in Israel, to prevent hyperinflation from worsening, automated raises had
to be halted. To assess inflation inertia in the Eurozone and modify monetary policy

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accordingly, the ECB established an inflation persistence network (Geronikolau, et al.,
2020).
Since the implementation of economic reforms in the year 1986, Vietnam has
experienced a continuous transition from a centrally planned to a "socialist oriented
market economy”. Liberalization policies in the year 1990 resulted in fast rising exports
and significant economic growth, with real GDP growth with an average of 9% per year.
Since then, development has decelerated, hitting 5 percent in the year 2012, owing to
stricter monetary and fiscal policies and global economic crisis spillovers (World Bank,
2012). Concurrently, inflation declined substantially in the year 2012, with inflation
dropping down from 18.1% at the end of the year 2011 to 6.8% by the end of the year
(Bhattacharya, 2014).
During the latter part of the year 1980 and early 1990s, Vietnam faced hyperinflation.
Inflation decreased from annual rates of almost 300% from the year 1986 to 1988 to less
than 20% in the year 1992 due to tight monetary and fiscal policy (Camen, 2006;
Maliszewski, 2010). In the late 1990s and early 2000s, inflation remained low but
unfortunately, GDP declined. Due to surplus capacity and low commodity prices,
Vietnam has undergone two years of lenient deflation from year 2000 to year 2001. Late
in 1999, the economy began to recover, but at a stagnant pace than in the early 1990s
(Bhattacharya, 2014).

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2.2.

Unemployment

Jahoda (1982) stated that unemployment is one of the most crucial issues nowadays.
According to Ndzwayiba (2020), a person who is unemployed is identified as someone
who doesn’t have a job but is already at working age, has the ability and willingness to
work, and actively looking for work. Similar to The Lumen Learning Course (2005)
viewed unemployment as basically “joblessness”. People who are unemployed and
passionately looking for work are said to be in this circumstance.
According to Chappelow (2020), when a person who is actively looking for work is
unable to obtain work, they are said to be unemployed. Furthermore, unemployment is
frequently employed as an indicator for the state of the economy. Mlatsheni and
Leibbrandt (2011) support this theory by emphasizing the alarmingly high rate of
unemployment and worklessness as the single most important contribution to the
maintenance of social marginalization on a large scale.
All things considered, it is critical that we recognize that Unemployment is an important
economic indication since it reflects employees' ability or inability to find work and
become a part of the economy's productive output (Chappelow, 2020). This tendency
could be attributed to the impact of the global crisis on output development and
employment, to production structure changes, and labor's diminishing marginal utility
as a result of cost constraints, as Van Aardt suggests (2012).
On the other hand, not all causes of joblessness indicates unemployment. The Bureau of
Labor Statistics (2020) stated that if someone stops seeking for work, the BLS does not
include them in the unemployment rate. Because they are no longer looking for work,

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someone who retires, returns to school, or leaves the job to care for children or other
family members is not considered unemployed. Even though they would prefer to work,
the BLS does not consider them unemployed unless they have looked for work in the
previous month. Marginally unemployed people have looked for work in the last year
but not in the previous month. The "real unemployment rate" is what the BLS calls it.
2.3.

Relationship Between Inflation and Unemployment

Many researches have been carried out to theoretically explain the relation between
inflation and unemployment. Just like Philips (1958) who demonstrated that link
between the change in unemployment rate and monetary earnings is non-linear,
reversed, and stable. Büyükakın (2008) used the same concept and stated that at every
level of unemployment, monetary earnings move quicker as unemployment declines and
slower as unemployment rises.

Figure 2. Philips Curve

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Samuelson and Solow (1960) modified the original Phillips curve, which showed the
trade-off connection between monetary wages and the unemployment rate, into a
structure that displays the link between wages and unemployment. Rather than of
concentrating on the link between unemployment and the rate of change in nominal
wages, Samuelson and Solow calculated the association between inflation and
unemployment over the period 1934-1958. According to Hall and Hart (2012), the
statistical Phillips curve is used to analyze the structure that represents various inflation
and unemployment choices.
The stability of the link between inflation and unemployment reflected by the Phillips
curve has been questioned over time, as has the validity of the relationship between these
two variables in the long run. Yıldırım and Karaman (2003) raised that when the effects
of inflationary expectations are taken into account, it is argued that the Phillips curve
will not be stable over time, and that the inflation rate determined by selecting a point
on the curve will cause a change in expected inflation rate and a shift in the Phillips
curve. Phillips' analysis was later on developed with the help of several other economists
due to discrepancies in short and long term expectations (Uysal & Erdoğan, 2003).
Friedman (1977) studied the short-term and long-term effects of inflation and
unemployment separately. Friedman emphasized that the Phillips curve only reflects
reality in the short term, and that there will be no trade-off in the long run. According to
Altay et al. (2011), the Phillips curve is parallel to the horizontal axis in the long run at
the natural unemployment rate, implying that long-term unemployment is expected to
be at the natural rate level regardless of inflation. Friedman's notion of the Natural Rate
of Unemployment (NRU) is adapted to the Phillips Curve. There is always a trade-off
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between unemployment and inflation, according to Phelps and Friedman, but it is not in
the long run. The natural unemployment rate is governed totally by actual causes in the
long run (Rodenburg, 2007).
Instead of Friedman's Unemployment Rate, New Keynesian economists utilized the
Non-Accelerating Rate of Unemployment (NAIRU) in the 1980s. The notion of NAIRU
is quite similar to that of NRU. First, it was defined as Non-Inflationary Rate of
Unemployment by Modigliani and Papademos (1975). Tobin later transformed this
notion into NAIRU (1980). NAIRU is a steady unemployment rate that is inflation-proof
and does not cause inflation to rise (Ưzkưk & Polat, 2017). Monetarist and New
Keynesian views reach the same result in terms of the presence and slope of Phillips
curve. The interpretations and assumptions that support the finding, on the other hand,
are vastly different. The long-term elimination of the Phillips connection, according to
Monetarists, is attributable to the correction of expectations mistakes. The grounds for
this, according to Keynesians, include flexible wages and prices (Bayrak and Kanca,
2013).
Numerous economists believe that the link between unemployment and inflation is an
important feature of monetary policy (Liu & Rudebusch, 2010). Central banks usually
adopt monetary policies that allow them to keep inflation low. Central banks can only
keep inflation low by keeping unemployment high if there is an inverse or negative link
between inflation and unemployment. (Asid et al, 2011). As a result, the possibilities
will be between high inflation and low unemployment, or the other way around.
(Furuoka, 2007).

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Several researchers have carried out research into the link between unemployment and
inflation. Studies regarding the trade-offs, long-run, co-integration and causal
relationship between unemployment and inflation have been prominent in this field of
study. Bhattarai (2016) conducted a research in OECD countries and examine the tradeoffs happening between unemployment and inflation within each economy. These
economies' unemployment rates differ substantially, but inflation rates have stabilized
at lower levels as a result of inflation targeting policies introduced in them over the last
two decades (Bhattarai, 2016). Quarterly data series for inflation, unemployment, and
growth rate for OECD countries were gathered. Co-integration and Granger Causality
Analysis were used to test the long-run relations between the two variables. Tau-test and
z-stat test were used to test the co-integration between unemployment and inflation. The
results show that there is a significant co-integrating relation between these two
variables. Similarly, this research will also be setting its analysis through co-integration
and causality test but apparently, Autoregressive Distributed Lag (ARDL) bounds
testing approach will be used for co-integration and Error Correction Model based on
ARDL (ECM-ARDL) for causality analysis.
Another study conducted by Lepetit (2020) was about the trade-offs happening between
unemployment fluctuations and monetary policy. Lepetit (2020) concluded that when
both constant errors and labor market tightness elasticity with regard to labor
productivity are high, there is a significant trade-off between stabilizing inflation and
stabilizing unemployment.
Similarly, from 1980 to 2005, Puzon (2009) conducted a study in 4 ASEAN countries,
namely: Thailand, Philippines, Malaysia, and Indonesia which examines the relationship
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The relationship between inflation and unemployment in viet nam an ardl bounds testing approach

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