Budget deficit, money growth and inflation: Empirical evidence from Vietnam

This study empirically examines the nexus among budget deficit, money supply and inflation by using a monthly data set from January 1995 to December 2012 and a SVAR model with five endogenous variables, inflation, money growth, budget deficit growth, real GDP growth and interest rate. Since real GDP and budget deficit are unavailable on the monthly basis, we interpolate those series using Chow and Lin’s (1971) annualized approach from their annual series. Overall, we found that money growth has positive effects on inflation while budget deficit growth has no impact on money growth and therefore inflation. In addition, budget deficit is autonomous from shocks to other variables. The estimation results also reveal that the State Bank of Vietnam implemented tightening monetary policy in response to positive shocks to inflation by reducing money growth but the response was relatively slow because it took three months for the monetary authority to fully react to such shocks. Finally, interest rate was not an effective instrument for fighting inflation but it was significantly and positively influenced by inflation.