Exchange rate pass-through to Vietnam’s import and domestic prices

Abstract

This paper estimates the exchange rate pass through to Vietnam’s import prices and domestic inflation with monthly data from January 1999 to October 2011. By applying Vector Auto Regression methods, Impulse Response function, Variance Decomposition as well as combining with Granger causality, VAR stable, Lagrange multiplier tests, the results show that exchange rate passed through almost fully to import price index immediately and strongly at the first month, after that it fluctuates to go up and down next months. The transmission from exchange rate to consumer price index is smaller than to import price index but it penetrates with longer periods around 10 months. Expanding money supply just explains for variance of inflation 2.48%. But it is not the surprising result, because the State Bank of Vietnam conducts monetary policy timely and appropriately. The results of variance decomposition, however, reveal that the most important factor affecting on both import and consumer prices is domestic demand pressure (output gap) with 32% and 14% respectively. Therefore the policy recommendation should focus on controlling domestic demand pressure as a priority to cut down high inflation. Government also can be confident with easing monetary policy due to its small effect on inflation. Nonetheless, the economy still needs the stable exchange rate policy in order to keep the trust on domestic currency.