A study of solution to the inflation in vietnam from 2000 to present,graduation thesis

STATE BANK OF VIETNAM
BANKING ACADEMY
Foreign Language Faculty

GRADUATION THESIS

A STUDY OF SOLUTIONS TO THE INFLATION
IN VIETNAM FROM 2000 TO PRESENT

Supervisors:
Student:
ID number:

Prof. Dr. Tô Kim Ngọc
Nguyễn Thị Hiền Hạnh, M.A
Đinh Thị Huyền
11A7510055

Hanoi, June 2012


Graduation Thesis

ACKNOWLEDGEMENTS
I would like to forward the deepest of my appreciation and gratitude to my
supervisors, Ms. To Kim Ngoc (Prof.Dr.) and Ms. Nguyen Thi Hien Hanh (M.A.) for
their patience and constructive advice throughout the course of the thesis. Not only did
them help me with invaluable suggestions, I have also learned a lot from them. The
brotherly treatment they accorded me has served as an inspiration for the completion of
this study. I credit every piece of strength of this study to my supervisors and any
weakness to myself.

I also owe a great deal of gratitude to all banking staff at Techcombank – Hoan
Kiem Branch for the three –month internship, in which I experienced the professional
working environment and gained a considerable number of practical knowledge.
Moreover, I am deeply grateful for all my classmates in ATCB K11 of Banking
Academy and all my best friends for their timely encouragements and wonderful
discussions during all stages of the study.
Above all, I am indebted to my parents for their love, affection and sacrifice to
support me in completing this work.

Đinh Thị Huyền ATCB – K11 – Banking Academy

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ABSTRACT

One of the prime objectives of governments is achieving stable macroeconomic
condition. The objective requires that prices be kept to a reasonably stable level. High and
persistent inflation introduces uncertainties into the economy and may lead to the
slowdown of economic growth by discouraging domestic as well as foreign investments.
It may also cause balance of payments problems, high nominal interest rate and
unemployment rate.
The study aims at understanding the forces behind the current inflation process in
Vietnam, especially period 2000 to present. The findings suggest that the determinants of
inflation in Vietnam from demand-pull and cost-push causes. The most important forces
behind demand-pull inflation are easy monetary policy, ineffectiveness of fiscal policy,
weak management of foreign capital inflows. The long run determinants of cost-push

inflation, on the other hand, are the increase in resident’s income, the cost of imported
materials, the hike of gas and electricity prices, and the rising trend of interest rate.
To contain inflation, therefore, the Government implemented the number of
solutions such as not only the tight monetary and fiscal policies, but also export
encouragement, deficit reduction, price control as well as minimum wage reform.
Finally, the paper also figures out and assesses some weaknesses of all solutions
applied, followed by recommendations for further accurate and synchronous measures in
order to curb inflation, which stabilizes macroeconomic environment in a long period.

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TABLE OF CONTENTS

ACKNOWLEDGEMENTS ........................................................................................... i
ABSTRACT ...................................................................................................................... ii
TABLE OF CONTENTS .............................................................................................. iii
LIST OF FIGURES ........................................................................................................ v
LIST OF TABLES ......................................................................................................... vi
LIST OF ABBREVIATIONS ..................................................................................... vii
INTRODUCTION ........................................................................................................... 1
CHAPTER 1: BACKGROUND OF INFLATION .................................................. 3
1.1 DEFINITION OF INFLATION ................................................................................. 3
1.2 MEASURES OF INFLATION .................................................................................. 5
1.2.1

1.2.2
1.2.3
1.2.4.

Consumer Price Index (CPI) ...................................................................................................... 5
Production Price Indices (PPIs)................................................................................................. 5
Cost of Living Price Index (CLI) ............................................................................................. 5
Gross Domestic Product (GDP) Deflator inflation index ............................................... 5

1.3. CLASSIFICATIONS OF INFLATION................................................................ 6
1.3.1 Moderate inflation .......................................................................................................................... 6
1.3.2 Running inflation ............................................................................................................................ 6
1.3.3 Hyperinflation .................................................................................................................................. 6

1.4. CAUSES AND EFECTS OF INFLATION.............................................................. 6
1.4.1 Causes of inflation .......................................................................................................................... 6
1.4.2 Effects of inflation .......................................................................................................................... 8

1.5. INFLATION SITUATION IN SOME COUNTRIES ........................................... 11
1.5.1 Hyperinflation in Zimbabwe ................................................................................................... 11
1.5.2 Inflation in Venezuela ................................................................................................................ 13
1.5.3 Inflation in China ......................................................................................................................... 15

CHAPTER 2: INFLATION IN VIETNAM, PERIOD 2000 TO PRESENT ... 18
2.1 HISTORY OF INFLATION IN VIETNAM FROM 2000- 2012 .................. 18
2.1.1
2.1.2
2.1.3
2.1.4

Period 2000 – 2003 ..................................................................................................................... 18
Period 2004 – 2006 ..................................................................................................................... 19
Period 2007 – 2009 ..................................................................................................................... 20
Period 2010 – up to now ........................................................................................................... 20

2.2 CAUSES OF INFLATION IN VIETNAM ........................................................ 22
2.2.1 Demand -pull cause ..................................................................................................................... 23
2.2.2 Cost –Push causes ........................................................................................................................ 28

2.3 CONSEQUENCES OF HIGH AND UNSTABLE LEVEL OF INFLATION
VIETNAM ......................................................................................................................... 31
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2.3.1
2.3.2
2.3.3
2.3.4
2.3.5

GRADUATION THESIS

Unstable macroeconomic environment ............................................................................... 32
High nominal interest rate ........................................................................................................ 33
Decrease real income and living standard.......................................................................... 34
Impact on unemployment rate ................................................................................................ 35
Impact on balance of payments .............................................................................................. 36

2.4 SOLUTIONS APPLIED FOR CONTROLLING INFLATION IN
VIETNAM AND RESULTS.......................................................................................... 37
2.4.1
2.4.2
2.4.3
2.4.4
2.4.5

The tight monetary policy......................................................................................................... 37
The tight fiscal policy ................................................................................................................. 39
Boosting production and business, encouraging export, reducing trade deficit . 40
Minimum wage reform .............................................................................................................. 41
Price control, goods demand –supply balance ................................................................. 41

2.5 SHORTCOMINGS OF INFLATIONTORY SOLUTIONS APPLIED IN
VIETNAM ......................................................................................................................... 42
CHAPTER 3: RECOMMENDATIONS FOR FURTHER SOLUTIONS TO 44
CONTROL INFLATION IN VIETNAM ................................................................ 44
3.1
3.2
3.3
3.4
3.5
3.6
3.7

RESTORE CONFIDENCE IN POLICIES APPLIED ................................... 44
ECONOMIC RESTRUCTION ............................................................................ 45
INDEPENDENT STATE BANK OF VIETNAM ............................................ 46

ADMINISTRATIVE REFORM .......................................................................... 46
SELF- ANTI – INFLATION SOLUTIONS FOR ENTERPRISES ............. 47
STRENGTHEN SOCIAL WELFARE ............................................................... 47
ACCURACY AND SPEEDING UP INFORMATION DISSEMINATION
48
CONCLUSION .............................................................................................................. 49
REFERENCES .............................................................................................................. 50

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LIST OF FIGURES
Figure 1.1: Demand-pull inflation and Cost-push inflation curve ............................. 8
Figure 1.2: The short-term Phillips curve .................................................................. 9
Figure 1.3: China’s inflation rate from 2009 to 2011 .............................................. 16
Figure 2.1: The CPI in Vietnam, period 2000-2003 ................................................ 18
Figure 2.2: The CPI in Vietnam, period 2007-2009 ................................................ 20
Figure 2.3: Vietnam - CPI inflation from 2009 to the early 2012 ........................... 21
Figure 2.4: CPI in Vietnam , period Jan 2011 – Apr 2012 ...................................... 22
Figure 2.5: The credit growth, money supply and inflation, period 2000 -2011 ..... 23
Figure 2.6: The credit growth and M2 in Vietnam from 1994- the early 2012 ....... 24
Figure 2.7: Vietnam Government Budget, period 2000-2012 ................................. 25
Figure 2.8: The investment structure of the public sector, non-state and FDI, 19952010 .......................................................................................................................... 26
Figure 2.9: FDA, ODA, reimbursement in Vietnam, period 1997-2007 ................. 28

Figure 2.10: The gasoline prices in Vietnam, Jan 2011- Jan 2012 .......................... 29
Figure 2.11: Electricity price from March 2009 to 2011 ......................................... 30
Figure 2.12: Vietnam GDP growth rate from 2002 to 2012 .................................... 33
Figure 2.13: The real, nominal interest rate and inflation in VN, 2010 to June 2011
.................................................................................................................................. 34
Figure 2.14: Vietnam unemployment rate from Jan 2000 to Jan 2012 .................... 36
Figure 2.15: Vietnam balance of trade from Jan 02 to Jan 2012 ............................. 37

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LIST OF TABLES
Table 1.1: Hanke Hyperinflation index for Zimbabwe, 2007-2008 ........................ 12
Table 1.2: Global inflation rate: CPI YoY % change, 2008 .................................... 14
Table 2.1: Situation of some socio-economic indicators in 2004 (Unit: %)............ 19
Table 2.2: Growth rate of consumer prices period 2004 – 2006 (Unit: %) ............. 19
Table 2.3: ICOR in Vietnam, 2001-2007 ............................................................... 26
Table 2.4: The minimum wage of State-owned enterprises from 2001 to 2012 ..... 29
Table 2.5: The inflation and unemployment rate in Vietnam from 2000 to 2011 ... 35

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LIST OF ABBREVIATIONS

ASEAN

Association of Southeast Asian Nations

BCV

Venezuela’s Central Bank

CLI

Cost of Living Price Index

CPI

Consumer Price Index

EVN

Electricity of Vietnam Group

FDI

Foreign Direct Investment

FII

Foreign Indirect Investment

GDP

Gross Domestic Product

GOS

General Statistic Office

HHIZ

Hanke Hyperinflation Index for Zimbabwe

ICOR

Incremental Capital Output Ratio

IFC

International Financial Institution

IMF

International Monetary Fund

INPC

National Consumer Price Index

ODA

Official Development Assistance

OMO

Open Market Operations

PPIs

Production Price Indices

SBV

The State banks of Vietnam

SeABank

Southeast Asia Commercial Joint Stock Bank

SOEs

State-owned enterprises

USD

United State Dollar

VAT

Value Added Tax

VNBA

Vietnam Bank Association

VPBank

Vietnam Joint Stock Commercial Bank for Private Enterprises

WO

World Bank

WTO

World Trade Organization

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INTRODUCTION

Inflation has become an undeniable phenomenon that consumes non-stop efforts
from policymakers and the press that creates the pressure on the socio- economic status in
global scale, including Vietnam. Therefore, macroeconomic stability especially inflation
control –one of the four most pressing issues regarding macroeconomic stability (together
with exchange rate management, budget deficits and trade deficit) is the key item on
Vietnam’s policy agenda in the moment.
For more than two decades now, Vietnam underwent hyperinflation period
1980s-1990s. It is the persistent hyperinflation, the joining the World Trade
Organization (WTO) in 2006, the great influx of foreign exchange in 2007-2008, and the
global economic crisis that influenced the economy and triggered the economic
reforms since late 1980s.
Although the Government and State Bank of Vietnam (SBV) have attempted to
implement a number of solutions to curb inflation and stabilize the economy, the inflation
movement has still fluctuated from year to year because of these ineffective and
asynchronous remedies.
Hence, the paper examines inflation with the desire to understand more
comprehensively the causes and consequences both in theory and practice, especially in
Vietnam from 2000 up to the early 2012. So the study of “Solutions to the inflation in
Vietnam from 2000 to present” was carried out to answer some following questions:
 What is definition, causes and effects of inflation in theory?
 In cases of Vietnam, what are the main reasons and consequences impacting on
Vietnam’s economy, especially period 2000 to present?
 What are the solutions applied to curb inflation in Vietnam and the results?
 What are the shortcomings of these policies and recommendation for further
solutions?
Because inflation is closely related to various issues such as exchange rate, interest
rate, economic growth, unemployment, balance of payment, this study was conducted by
applying the systematic research methods, including dialectical materialism, materialistic
dialectics, inductive and deductive method, comparison and contrast, combined with the
illustration of tables and figures through secondary data collected from various sources.

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In summary, in order to support the readers and person interested in this topic, the
study is organized into three clear and coherent parts.
 Chapter 1: Background of inflation – in which the fundamental knowledge of
inflation in definitions, measures, types, causes and effects, and the study of
inflation in some countries are presented.
 Chapter 2: Inflation in Vietnam period 2000 to present – in which giving an
overview of inflation in Vietnam: the history, main causes and consequences on
the socio-economic situation and then the solutions applied and results.
 Chapter 3: Recommendations for further solutions – in which some suggestions
are released for tackling inflation in Vietnam.

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CHAPTER 1: BACKGROUND OF INFLATION
1.1 DEFINITION OF INFLATION
Inflation is a global phenomenon in present day. There is hardly any country in the
capitalist world today which is not afflicted by the specter of inflation. It is on account of
this that the phenomenon of inflation has widely attracted the attention of the economists
all over the world. However, there is no generally accepted definition of the term
“inflation” as it is a highly controversial term which has undergone many modifications.
Prof. Crowther defines inflation “as a state in which the value of money is falling
because prices are rising” (Inflation and Deflation, Sikkim Manipal University). But this
definition is defective and does not offer a complete picture of the phenomenon of
inflation. This definition has been criticized on two grounds:
First, according to Crowther every increase in the price level is inflationary and has
harmful effects on the economy. On the contrary, it serves as a stimulant for the revival of
economy.
Second, Prof. Crowther’s definition emphasizes the symptoms rather than the
causes of the disease. The rise in the price level is a symptom rather than the cause of
inflation. This definition fails to explain why the price level increase from time to time
Prof. Kemmerer, Professor of Economics and Finance at Princeton University
defines inflation as “Too much currency in relation to the physical volume of business
being done” (High prices and Inflation, 1920). However, this definition is not
satisfactory. Obviously this definition involves a comparison between the two quantities –
the volume of currency on the one side and the volume of physical goods and services on
the other side. The difficulty with this definition is that it suffers from vagueness. It is not
possible to determine accurately the demand for money. There is no dependable technique
whereby the physical volume of goods and services can be accurately converted into the
demand for money. As such Kemmerer’s definition cannot be looked upon as satisfactory
definition
Prof. Coulbourne emphasizes the same point as has been done by Prof. Kemmerer
in the above definition. He says “inflation is too much money chasing too few goods”
(Macroeconomic Analysis, 1983). Coulbourne’s definition also involves a comparison

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between the quantity of money on one side and the supply of goods and services on the
other one. This definition is subject to the same limitations as the definition of Kemmerer.
The above definitions given by Kemmerer, Coulbourne, belong to the same
category. They seek to establish causes and effects relationship between supply money
and price level. According to these definitions, the rise in price level is caused by an
increase in the supply of money. The increase in the supply of money is the cause; the rise
in the price level is the effect.
But the above cause and effect relationship between supply of money and the price
level was reversed in Germany in the post-war I period. In the other words, the
hyperinflation which took place in Germany in the post world war period could not be
explained by the normal cause and effect relationship between supply of money and the
price level as pointed out in the above definitions. It was the rise in price which caused
the expansion of money supply over business requirements pushes up the price level.
Price inflation is the second stage of inflation when the rising price level necessitates a
rapid expansion of the money supply. During the price inflation the prices rise with such
rapidity that even the money supply cannot keep pace with them. This stage of inflation is
referred to as hyper inflation. To our mind, Prof. Einzing defines inflation, “Inflation is
that state of disequilibrium in which an expansion of purchasing power tends to cause or
is the effect of an increase of the price level” (Economic Research, 1983). As analysis of
this definition reveals the fact that the rise in the price level is not only the result but also

the cause of money supply.
According to Webster’s New Universal Unabridged Dictionary published in 1983,
the second definition of inflation after “the act of inflating or the condition of being
inflated” is:
“An increase in the amount of currency in circulation, resulting in a relatively
sharp and sudden fall in its value and rise in prices: it may be caused by an increase in
the volume of paper money issued or of gold mined, or a relative increase in expenditures
as when the supply of goods fails to meet the demand.”
This definition includes some of the basic economics of inflation and would seem
to indicate that inflation is not defined as the increase in prices but as the rise in the
supply of money that causes the increase in prices i.e. inflation is a cause rather than an
effect.

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So between 1983 and 2000 the definition appears to have shifted from the cause to
the result. Also note that the cause could be either an increase in money supply or a
decrease in available goods and services.
1.2 MEASURES OF INFLATION
1.2.1 Consumer Price Index (CPI)
Inflation is usually estimated by calculating the inflation rate of a price index,
usually the Consumer Price Index. The Consumer Price Index measures prices of a
selection of goods and services purchased by a "typical consumer”. The inflation rate is

the percentage rate of change of a price index over time.
1.2.2 Production Price Indices (PPIs)
Producer price indices (PPIs) measures average changes in prices received by
domestic producers for their output. This differs from the CPI in that price subsidization,
profits, and taxes may cause the amount received by the producer to differ from what the
consumer paid. There is also typically a delay between an increase in the PPI and any
eventual increase in the CPI. Producer price index measures the pressure being put on
producers by the costs of their raw materials. This could be "passed on" to consumers, or
it could be absorbed by profits, or offset by increasing productivity. In India and the
United States, an earlier version of the PPI was called the Wholesale Price Index.
1.2.3 Cost of Living Price Index (CLI)
A cost-of-living price index measures the changing cost of a constant standard of
living. The index is a scalar measure for each time period. Usually it is a positive number
which rises over time to indicate that there was inflation. Two incomes can be compared
across time by seeing whether the incomes changed as much as the index did.
1.2.4. Gross Domestic Product (GDP) Deflator inflation index
In economics, the GDP deflator (implicit price deflator for GDP) is a measure of the
level of prices of all new, domestically produced, final goods and services in an economy.
GDP stands for gross domestic product, the total value of all final goods and services
produced within that economy during a specified period.
(Source: Measures of inflation, Wikipedia)

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1.3. CLASSIFICATIONS OF INFLATION
1.3.1 Moderate inflation
Most stable nations in the world have to deal with inflation at some level and try to
maintain a target inflation rate of around 1-2% but depending on the state of the country’s
economy it can reach up to 6%. You could consider this a natural rate of inflation or
moderate inflation that is almost impossible to eliminate.
1.3.2 Running inflation
When the movement of price accelerates rapidly, running inflation emerges.
Running inflation may record more than 100 per cent rise in prices over a decade. Thus,
when prices rise by more than 10 per cent a year, running inflation occurs. Economists
have not described the range of running inflation. But, we may say that a double digit
inflation of 10-20 per cent per annum is a running inflation. It is defined as chronic
because the high inflation rate persists over time without any downward movement,
possibly leading to hyperinflation rate.
1.3.3 Hyperinflation
During this period, prices rise very fast, at double or triple digit rates from more than 20
to 100 percent per annum or more and become absolutely incontrollable. Such a situation
brings a total collapse of the monetary system because of the continuous fall in the
purchasing power of money.
(Source: Types of inflation, www.rateinflation.com)
1.4. CAUSES AND EFECTS OF INFLATION
1.4.1 Causes of inflation
 Demand – pull Inflation
According to the demand-pull theory, prices rise in response to an excess of
aggregate demand over existing supply of goods and services. It is also called excessdemand inflation. In the excess-demand theories of inflation, excess demand means
aggregate real demand for output in excess of maximum feasible, or potential, or full
employment, output (at the going price level).

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The demand-pull theorists point out that inflation (demand-pull) might be caused,
in the first place, by an increase in the quantity of money. Demand-pull or just demand
inflation may be defined as a situation where the total monetary demand persistently
exceeds total supply of real goods and services at current prices, so that prices are pulled
upwards by the continuous upward shift of the aggregate demand function. Causes of
Demand-pull inflation are increase in public expenditure, increase in investment, and
increase in money supply (Shaikh Saleem, Business Environment, 2nd Edition, 2006).
 Cost – Push Inflation
Cost push inflation or cost inflation is induced by the wage-inflation process..
Theories of cost-push inflation (also called sellers’ or mark-up inflation) came to be put
forward after the mid-1950s.They appeared largely in refutation of the demand-pull
theories of inflation and two important common ingredients of such theories are
1) That the upward push in costs is autonomous of the demand conditions in the
concerned market
2) That the push forces operate through some important cost component such as
wages, profits (mark up), or materials cost.
Accordingly, cost-push inflation can have the forms of wage-push inflation,
profit-push inflation, material-cost push inflation, or inflation of a mixed variety in which
several push factors reinforce each other and that the increase in costs is passed on to
buyers of goods in the form of higher prices, and not absorbed by producers. Thus, a rise
in wages leads to a rise in the total cost of production and a consequent rise in the price
level, because fundamentally, prices are based on costs. It has been said that a rise in

wages causing a rise in prices may, in turn, generate an inflationary spiral because an
increase would motivate the workers to demand more wages (Shaikh Saleem, Business
Environment, 2nd Edition, 2006).

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Figure 1.1: Demand-pull inflation and Cost-push inflation curve

Cost-push inflation

Demand-pull inflation

P

ASLR

ASSL
ASLR

P

AD
ASSR1

P1

E1
AD1

E1

P1

P0

E

P0

E0
AD0
y* y0 y1

y

y1

y0

y*

y

Source: The Macroeconomic Theory book
1.4.2 Effects of inflation
 Positive effects
If moderate inflation existing in a long period and anticipated by all members in
society, this inflation rate would have positive impacts on the development of economy
and society.
First, when low inflation rate happens, the domestic currency depreciates slightly
against foreign currencies. This is a good chance for enterprises to promote the export of
goods, increase foreign exchange, and encourage development of domestic production.
Second, when the economy has not reached full capacity, reasonable inflation will
impulse economic development as it increases the volume of money in circulation,
provides more capital for production and business units, stimulates the consumption of
the Government and the people.
Moreover, two economic indicators closely followed are inflation and
unemployment. These two indicators have inverse relationship with each other. The

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economist, Alban William Phillips, brought out “Theory between inflation and
employment” to demonstrate this point of view. Thus, a country in a given time can take
full advantage of the inflation target at a moderate level to cut unemployment rate. This
can be proved by the short-term Phillips curve below

Figure 1.2: The short-term Phillips curve

Source: Wikipedia
 Negative effects
The danger of inflation does not result from the level of inflation, but also its
sudden appearance. When the inflation rate changes unexpectedly, it reveals abnormal
fluctuations in currency values and misleads the measures of value relationships, which
affect all socio-economic factors.
i.

Uncertainty for macroeconomic environment

The extraordinary volatility of the inflation rate from time causes the investors
difficult to determine exactly the benefit of the investment. This creates a short-term
psychotherapy when they make investment decisions, especially on the long-term
investment projects. On the other hand, instability of income can lead investors prefer to
invest in the financial assets rather than on the real investment projects. As a result, social
resources are allocated in ineffective way that affects economic growth.

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In term of inflation volatility, financial decisions are also distorted; enterprises
prefer short-term loans rather than long-term ones with a fixed rate which contained the

potential interest rate risk.
In addition, inflation also has negative effects on labor market when employees,
workers find the way to require the nominal wage increase with the strikes or the hazard
of higher inflation rate. In this regard, inflation halts economic growth.
ii.

Redistribution of national income and the wealth of society

This effect stems from the different types of assets and debts in the population.
Specifically, owners hold the amount of cash, deposits or securities, etc. then they lose
because the value of money decreases. However, if they hold gold, foreign currencies,
and real estate, they will receive benefits as a result of raising relatively value of these
assets.
Besides, the lenders with a fixed rate also lose whereas the borrowers obtain profits
because the borrowers will pay the lenders the devaluated currency due to inflation. The
employees with fixed income, especially the poor, will suffer as well although their
nominal income increases.
“They depend on daily income; they may be hungry on the race to buy goods in
the condition of high inflation rate. They have no place to go to be protected,” Benedict
Bingham IMF expert analyzed.
iii.

High interest rate

Inflation makes nominal interest rate increased due to the rise in the expected
inflation rate. The problem will arise when the expected inflation rate constituting the
nominal interest rate does not match inflation rate in reality and affects the real interest rate.
Increasing interest rate also means the rise in lending rate, which leads to
businesses and individuals difficult to access bank loans or receive lower profits during
the soaring inflation. This, in turn, influences savings, investment, and economic growth

at last.
iv.

Impacts on the balance of international payments

Assuming other factors constant, once inflation climbs, the domestic currency
devalues relatively over foreign currencies or in other words, the exchange rate increases.

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Hence, the trade balance improves thanks to the increase of export activities – a good sign
for inflation.
However, the drawback of import operations is a bad signal. Some manufacturing
firms using imported materials will be affected negatively by the rising trend of exchange
rate. Therefore, profits will decline not only in short-term but also in long-term period,
and the prices of outputs will soar to a higher level, continuing the whirl of inflation.
v.

Impacts on the unemployment rate

During the 1960’s, people believed that there was a natural rate of unemployment,
and in long-term, inflation does not impact upon unemployment at all (in short-term, the
employment rate will fall as price increases.

However, as companies increase their wages, employment will return back to its
natural level, economist Keynes observed that increased consumption would result in
employment increase. This, indeed, tended to offset against raising inflation. If employment
was higher than the natural rate of unemployment, inflation rate will be higher.
According to Friedman's theory, popular in the 1980's, higher inflation leads to
higher unemployment, since higher inflation tends to be associated with more inflation
volatility and greater inflation uncertainty. This uncertainty reduces economic efficiency
as contracting arrangements must adjust. Similarly, disinflation has exactly the same
result significantly in increasing economic uncertainty and acting as an incentive to fail to
spend money, leading to decrease consumption and increase unemployment.
1.5. INFLATION SITUATION IN SOME COUNTRIES
In order to understand comprehensively the thorough knowledge of inflation, the
thesis provides some outstanding cases of inflation in history. First, it is Zimbabwe which
experienced hyperinflation and reached to an uncountable percentage. After that, the
study gives a deep look at the inflation in Venezuela that recorded the highest inflation
rate in recent years, followed by the inflation in our neighbor – China whose economic
characteristics are similar to ours.
1.5.1 Hyperinflation in Zimbabwe
Zimbabwe is the first country in the 21st century witnessing hyperinflation. In
February 2007, Zimbabwe’s inflation rate topped 50% per month, the minimum rate required

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to qualify as a hyperinflation (50% per month is equal to a 12,875% per year). Since then,
inflation has soared (On the Measurement of Zimbabwe’s Hyperinflation, 2009).
Absent current official money supply and inflation data, it is difficult to quantify
the depth and breadth of the still-growing crisis in Zimbabwe. To overcome this problem,
Cato Senior Fellow Steve Hanke has developed the Hanke Hyperinflation Index for
Zimbabwe (HHIZ). This new metric is derived from market-based price data and is
presented in the accompanying table for the January 2007 to present period. Since 14
November 2008, Zimbabwe’s annual inflation rate was 89.7 Sextillion (1021) %.

Table 1.1: Hanke Hyperinflation index for Zimbabwe, 2007-2008
Hanke Hyperinflation Index for Zimbabwe (HHIZ)
Monthly Inflation
Date

Index

Rate

Annual Inflation Rate

5-Oct-07

219

165.00%

2-Nov-07

642

193.00%

28-Dec-07

2,010.00

61.50%

215000%

25-Jul-08

157,000,000.00

566.00%

317000000%

29-Aug-08

6,330,000,000.00

3190.00%

9690000000%

26-Sep-08

794,000,000,000.00

12400.00%

471000000000%

3-Oct-08

3,570,000,000,000.00

15400.00%

1630000000000%

10-Oct-08

32,300,000,000,000.00

45900.00%

11600000000000%

17-Oct-08

1,070,000,000,000,000.00

493000.00%

300000000000000%

24-Oct-08

124,000,000,000,000,000.00

15600000.00%

26100000000000000%

31-Oct-08

24,600,000,000,000,000,000.00

690000000.00%

3840000000000000000%

7-Nov-08

4,890,000,000,000,000,000,000.00

15200000000.00%

593000000000000000000%

14-Nov-08

853,000,000,000,000,000,000,000.00

79600000000.00%

89700000000000000000000%

Sources: Imara Asset Management Zimbabwe and author’s calculations
This level of inflation in Zimbabwe impacted on the poor residents of the country
widely and deeply. Zimbabweans purchased a sandwich for Zimbabwean $50 million.
One kg of potatoes cost Zimbabwean $17 million. Effectively, this meant that the value of

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Zimbabwean dollar reached almost to zero. Hence 50-million Zimbabwean dollars
equaled to only US 1 dollar.
Zimbabwe’s hyperinflation was destroying the economy, pushing more of its
inhabitants into poverty, and forcing millions of Zimbabweans to emigrate. In addition,
hyperinflation robbed people of their savings and financial institutions of their capital
through real (inflation-adjusted) interest rates that was actually negative.
Inflation in Zimbabwe began from a program of land reforms that primarily
focused on taking land from white farmers and redistributing those properties and assets
to black farmers, which sent food production and revenues from export of food
plummeting. The result was that to pay its expenditures Mugabe’s government
and Gideon Gono’s Reserve Bank printed more and more notes with higher face values.
After that, inflation rate grew dramatically from year to year and led to
hyperinflation since 2007. The root cause of the hyperinflation is that government policies
have forced the central bank to print money.
Hyperinflation was halted within months when government took the necessary
steps. The direct solution was a credible promise to stop printing unlimited amounts of

money, declared some foreign currency to be the nation's official currency. To facilitate
commerce, it was less important which currency was adopted than that the government
standardized on a single currency. Short of abandoning the Zimbabwean dollar,
Zimbabwe could enact a strict monetary policy. The supply of Zimbabwean dollars would
be limited, perhaps by a currency board such as in Hong Kong, which has no other
constraint than to maintain the fixed exchange rate. Currently Zimbabwe uses a
combination of foreign currencies, but mostly US dollars to curb inflation.
1.5.2 Inflation in Venezuela
Venezuelan has been suffering from high inflation rates for many recent years. As
shown in Table 2 below, the highest inflation rate went to Venezuela and the Ukraine at
31%, followed by Sri Lanka (26%), Vietnam (25%), and Egypt (19.7%) in 2008.
Historically, from 1973 until 2012, Venezuela inflation rate averaged 26.5% reaching a
peak of 115.18% in September of 1996 and a record low of 3.22% in January of 1973.
Inflation led businesses into poor maintenance, and driving some to near or full
bankruptcy and fluctuating macroeconomic environment.
The government continues to insist the problem caused by "speculation" and by
"monopolies". They seem to ignore a very simple fact: They are printing a lot of money,

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and this increase in the money supply is not matched by an increase in the supply of
goods and services (Venezuela’s inflation rate: Causes and Solutions, 2011).
Although the rate has been still high, in early 2012, Venezuela’s monthly rate of

inflation as measured by the National Consumer Price Index (INPC) was 1.1% in
February, the lowest since the current system of measuring inflation with national
coverage began at the start of 2008. The statistics, reported by Venezuela’s Central Bank
(BCV), confirm that inflation has been decreasing for three months in a row, recorded at
1.8% in December 2011 and 1.5% in January 2012.The annualized rate of inflation has
also decreased, calculated at 25.3% from February 2011 – January 2012, compared with
28.7% of the previous year.

Table 1.2: Global inflation rate: CPI YoY % change, 2008

Source: Bespoke Investment Group

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The Venezuelan government argues that slowed inflation was thanks to the
government social investment, especially in health and education, as well as policies
encouraging increased national agricultural production. “The social investment that the
Bolivarian Government has made in these years is already reaching $500 billion,”
Minister Jorge Giordani said on state television channel VTV.
The minister explained that government social spending has prioritized providing
free health and education services to the population, which in turn allowed Venezuelans
to spend more on foodstuffs. He further indicated that the government’s Mission Agro Venezuela, launched in January 2011 to provide low interest loans and training to
farmers, has played a key role in reducing inflation, as “there is no doubt that one of the

causes of the decrease in inflation is the necessary internal supply that must be produced
in the country”.
The Venezuelan government has already launched several new social programs
over the previous 12 months, including its mass public housing program in May 2011,
welfare payments for families in extreme poverty and increased pension provision in
December 2011, and the new employment and training program, whose registrations
began in January this year.
1.5.3 Inflation in China
The economies of China and Vietnam have a lot of similarities when looking back
to the history. First of all, both nations have built the socialist economy, China since 1949
and Vietnam since 1975, when the country was unified. China and Vietnam started to
develop the economy based on agriculture.
In addition, both economic reforms have had numerous similar characteristics of
the background leading to reform, the initial socio-economic conditions and methods of
reforming and economic management. However, until now, the economies of two nations
have witnessed many differences. China has developed and gradually become a key
economic power just after the United States.
Therefore, any uncertainty in the Chinese economy, especially inflation, is the
concern of the rest nations.
According to National Bureau of Statistics of China, the inflation rate was
recorded at 3.4% in April 2012. Historically, from 1994 until 2012, China’s inflation rate

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averaged 4.3% reaching an all time high of 27.7% in October 1994 and a record low of 2.2% in March 1999. That means Chinese economy has still developed and not stabilized.

Figure 1.3: China’s inflation rate from 2009 to 2011

Source: National Bureau of Statistics of China
There are a few key factors that will continue to drive China's pace of inflation
(The Causes of China inflation and its effects, 2010).
The obvious culprit is the Chinese government restricted currency control that had
artificially depreciated the foreign exchange rate of the Yuan. The cheaper Chinese
currency was one of the contributing factors to a strong manufacturing and export
business activity. But it also has its downside by making any imported food and energy
resources more expensive.
China's unprecedented rate of development has contributed to strong demand-pull
inflation. Rampant consumerism coupled with a large growing population will continue to
drive the increase in consumer demand. This consumer led demand in turn because of a
corresponding increase in business activities and ultimately production cost.
There is also the expectation of future economic development and potential
appreciation of the Chinese Yuan (also known as Ren Min Bi). This has led to huge
inflows of both hot money and legitimate long term investments into the China economy.
In order to fight inflation, China’s economic officials has implemented a very
successful strategy to repel the largest economic risk destabilizing, including raising
interest rates four times in October 2010, asking banks to keep more money in reserve to

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limit lending and tightening monetary policy. After reaching to the top of 6.5% in July
2011, the CPI fell down to 4/5% in early 2012 and is expected on the rise trend in the next
months. This situation reflects the effectiveness of policies applied by the Chinese
government from which many countries especially Vietnam can follow in China’s
footsteps.

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