1.3.1. Fisher Effect

1.3.1.1. Definition

The Fisher Effect is an economic hypothesis stating that the real interest rate

is equal to the nominal rate minus the expected rate of inflation.

1.3.1.2. How it works/Example:

In the late 1930s, U.S. economist Irving Fisher wrote a paper which posited

that a country's interest rate level rises and falls in direct relation to

its inflation rates. Fisher mathematically expressed this theory in the following

way:

R Nominal = R Real + R Inflation

The equation states that a country's current (nominal) interest rate is equal to

a real interest rate adjusted for the rate of inflation. In this sense, Fisher conceived

of interest rates, as the prices of lending, being adjusted for inflation in the same

manner that prices of goods and services are adjusted for inflation. For instance, if

a country's nominal interest rate is six percent and its inflation rate is two percent,

the country's real interest rate is four percent (6% - 2% = 4%).

1.3.1.3. Significance

The Fisher effect is an important tool by which lenders can gauge whether or

not they are making money on a granted loan. Unless the rate charged is above and

beyond the economy's inflation rate, a lender will not profit from the interest.

Moreover, according to Fisher's theory, even if a loan is granted at no interest, a

lending party would need to charge at least the inflation rate in order to retain

purchasing power upon repayment.

Despite the deceleration in inflation, Vietnam has suffered from higher and

more volatile inflation compared to most emerging Asian economies since mid-

2007 (Figure 1). This in turn is a reflection of weaknesses in the macroeconomic

policy framework. In particular, monetary policy in Vietnam has been criticized for

lack of transparency and predictability, and for following multiple—and at times

conflicting—objectives (International Monetary Fund (2010), Moody’s Investor

Services (September 2011)). In practice, four key objectives have been guiding

monetary policy in Vietnam in the recent past, namely promoting economic

growth, fighting inflation, stabilizing the exchange rate, and preserving the stability

of the financial system. There is also prevalent use of caps on interest rates and

controls on credit.

Figure 1. Emerging Asia: Headline Inflation, 2000-2012 quarterly data

Source: CEIC Data Company Ltd.

Although the monetary policy framework in Vietnam has been criticizedby

various (internal and external) observers, empirical work to see how the monetary

policy transmission mechanism operates in practice and affects inflation has been

relatively limited to date. Moreover, it has at times provided conflicting results and

policy conclusions. This paper aims to make a contribution in this area.

Inflation rose sharply as growth picked up strongly between 2004 and mid-2008, reflecting sustained increases in international commodity prices and growing excess demand, due in large part to heavy investment by state-owned enterprises and a surge in foreign direct investment in the run-up to Vietnam’s accession to the World Trade Organisation. Headline inflation reached a peak of almost 25 percent inthe third quarter of 2008 but then started to decline sharply as a result of weakening domestic demand and lower food and energy prices, falling to 2.4 percent by the third quarter of 2009.

However, headline inflation then started to pick up again towards the end of 2009, reflecting in part the impact of the economic stimulus package introduced in response to the global crisis. A sizeable fiscal policy stimulus amounting to around 5 percent of GDP was executed in 2009, while the base (prime) rate was cut by a total of 700 basis points between October 2008 and February 2009 and kept at 7 percent until November 2009. Meanwhile, liquidity 5 was injected through open market operations as well as a much lower reserve requirement ratio on Vietnamese dong deposits. In 2010 the State Bank of Vietnam initially and temporarily tightened monetary policy to control inflation, but soon reversed its monetary policy stance and loosened monetary policy again in the middle of the year. This contributed to headline inflation rising more-or-less steadily to reach 20.2 percent in the third quarter of 2011. Headline inflation then declined more-or-less steadily to reach a low of 6.3 percent in 2012Q3, reflecting to a large extent the impact of a package of monetary and fiscal policy tightening measures announced by the government at end-February 2011 and known as ‘Resolution 11’. More recently headline inflation has shown signs of picking up again.

Core inflation has followed a similar pattern to headline inflation, but both the rises and declines in inflation have been more gradual (Figure 2)

Figure 2. Vietnam: CPI Inflation, 1999-2012 quarterly data

Source: General Statistics Office

After that, 2013 saw a positive impact by the government’s monetary policy management on Vietnam’s economy. The State Bank of Vietnam’s effective and timely measures made important contributions to realizing the government’s economic management targets to stabilize the macro-economy, control inflation, and lift the economy out of stagnation.

2013 was an impressive year for the Vietnamese economy. Inflation was controlled and there were signs of recovery despite low economic growth. The General Statistics Office reported that, although GDP increased only 5.42%, the

consumer price index was just 6.04%, the lowest rate in the past decade. This success was mainly due to the government’s macro-economic policies, especially its monetary policy.

A key achievement of Vietnam’s banking sector for the year was to drop the lending interest rate – a move that strongly influenced the domestic business community and contributed to the national economic recovery. Statistics by the banking sector showed that the average annual lending rate was 10%, less than half of the 22% seen two years before.

The State Bank of Vietnam stabilized the domestic gold market by asking credit institutions to gradually reduce capital lending in gold to wipe out gold-related risks and end the goldalization.

2013 also saw preliminary success in the restructuring of the banking sector, particularly commercial banks. Vietnam consolidated credit institutions via mergers or dissolutions. It also completed the equitization of 4 state-owned commercial banks. By the end of last year, the Vietnam Asset Management Company had purchased more than 1.6 billion USD worth of bad debts.