Effects of trend inflation on monetary policy and fiscal policy shocks in Vietnam

PurposeThis paper analyzes variations in effects of monetary and fiscal shocks on responses of macroeconomic variables, determinacy region and welfare costs due to changes in trend inflation.Design/methodology/approachThe authors develops the New-Keynesian model, which the central banks can employ either nominal interest rate (IR rule) or money supply (MS rule) to conduct monetary policies. They also use their budgets for capital and recurrent spending to conduct fiscal policies. By using simulated method of moment (SMM) for parameter estimation, the authors characterize Vietnam's economy during 1996Q1 -2015Q1.FindingsThe results report that consequences of monetary policy and fiscal policy shocks become more serious if there is a rise in trend inflation. Furthermore, the money supply might not be an effective instrument and using the government budget for recurrent spending produces severe consequences in the high-trend-inflation economy.Originality/valueThis is the first paper that examines the effects of trend inflation on the monetary and fiscal policy implementation in the case of Vietnam.