For Vietnam's Monetary Policy Independence

The total weight of external factors has generally reached the same level as that of domestic factors (excluding their own changes). However, the total influence of external factors remains quite low, approximately 15%.

Based on the results obtained from the research model, some recommendations for the process of HNTC and the operation of Vietnam's monetary policy to increase the effectiveness of achieving the final goal, while ensuring the sustainability of the policy in relation to other goals in the context of increasing financial globalization as an inevitable trend will be mentioned next.

5.2 POLICY IMPLICATIONS

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5.2.1 For Vietnam's monetary policy independence

The impossible trinity in international macroeconomics has shown that the choice cannot be made simultaneously between HNTC, exchange rate stability and monetary policy independence. With the fact that the VND/USD exchange rate is managed at a high level of stability, the research results have also confirmed that HNTC has a negative impact on monetary policy independence in Vietnam. Increasing HNTC reduces monetary policy independence and this impact appears right in the first quarter. Although it is only a short-term impact, when the monetary policy loses the ability to use its management tools independently of external shocks, the short-term results become uncertain, leading to difficulty in achieving the set goals in the long term. Therefore, to reduce the tension in this relationship, Vietnam needs to pay attention to the remaining factors that also have an impact on increasing tension such as exchange rate stability or reducing the tension from foreign exchange reserves. The increase in HNTC reduces the independence of monetary policy more strongly if the exchange rate is kept stable, the Impossible Trinity theory has shown and in reality Vietnam also encounters this situation. Therefore, the flexible consideration of exchange rate needs to be mentioned to harmonize the inverse relationship between HNTC and the independence of monetary policy in Vietnam. In addition, many empirical studies and practical studies of countries have recognized the positive role of foreign exchange reserves in supporting the independence of monetary policy in the trend of increasing HNTC with the world. The results of this role in Vietnam have not been

Evidence, may stem from the fact that the scale of Vietnam's foreign exchange reserves is not strong enough to see a clear impact or may be due to the fact that the research sample size is not large enough to consider this impact in the short term. With the current situation, when Vietnam does not have the conditions to access other sources of support, foreign exchange reserves still need to be concerned to protect against the capital flow reversal phase, reducing risks in the HNTC process. Some related solutions will be mentioned in detail as follows:

5.2.1.1 Flexible exchange rate management

The research results of the thesis show that long-term exchange rate stability limits the independence of monetary policy in Vietnam. However, in the short term, exchange rate stability has a supporting effect on monetary policy operations by increasing market confidence in domestic policy commitments. The exchange rate as considered has a very high level of stability throughout the research period. Therefore, long-term monetary policy operations need to allow the exchange rate to move more, but the level of flexibility needs to be expanded step by step to avoid losing market confidence.

A stable exchange rate has many advantages, especially for developing countries seeking to build confidence in their economic policies, as research from the thesis also found in Vietnam. And a pegged currency can also result in lower inflation rates (Duttagupta, Fernandez & Karacadag 2005). However, countries with highly stable exchange rates are more vulnerable to currency crises, as well as dual currency and banking crises, than countries with more flexible exchange rate regimes. As economies become more closely linked to international financial markets, the benefits of exchange rate flexibility may increase (Duttagupta, Fernandez & Karacadag 2005). As cross-border linkages deepen, countries with pegged exchange rate regimes are more exposed to capital flow volatility, while flexible regimes provide better protection against external shocks and a higher degree of monetary policy independence. Therefore, the SBV should first of all operate the exchange rate more flexibly, with increases and decreases in both directions to avoid the psychology of following the trend of one-way price increases and hoarding foreign exchange.

currency, causing constant tension in the foreign exchange market. Second , reduce the frequency of buying and selling and actively intervene in the market, so that the exchange rate gradually follows the direction of market supply and demand. Third , increase information to the market on foreign exchange reserves and the balance of payments to increase market confidence in monetary policy and exchange rates. On this issue, the State Bank has recently provided information more frequently and needs to continue to do so with greater initiative and frequency. Fourth , gradually loosen control measures such as current account and capital account limits to increase foreign exchange revenues. Capital controls need to be loosened in a roadmap, this issue will be mentioned in the solution on HNTC. The government may face conflicting goals. On the one hand, it is necessary to sell foreign exchange to prevent excessive devaluation that negatively affects economic activities. On the other hand, to maintain market confidence, the SBV needs to signal that it will not intervene to protect a specific exchange rate. In this situation, the experience of many countries is to gradually abandon the market-making role of the central bank, remove barriers to foreign exchange market activities, accept greater exchange rate volatility, while allowing interest rates to rise to counter market pressure and monitor market transactions to determine the source and direction of order flows.

5.2.1.2 Increase the size of foreign exchange reserves

The primary concern about the adverse effects or risks of deeper industrialization in developing countries is the increased exposure to volatile short-term capital flows (so-called “hot money”), which are capital flows that are subject to sudden stops and reversals in response to adverse changes in domestic and international markets (Calvo 1998). Foreign exchange reserves can reduce both the probability of sudden stops and the severity of output declines in response to such changes. Historically, foreign exchange reserves have been assessed as a support for imports and are often measured appropriately by comparing foreign exchange demand for a given number of weeks of imports. However, the need for foreign exchange reserves as a hedge against financial market risks has increased over time (Cheung & Ito 2007). Emerging market economies have experienced

There have been frequent crises since the 1980s, such as Latin America in the 1980s, Mexico in 1995, East Asia in 1997, Russia in 1998, Turkey in 1994 and 2001, Brazil in 1999, and Argentina in 2002 and 2018. A prominent feature of these crises is the sudden stop in capital flows, disrupting the financial system and causing large and lasting output losses. Over time, economies have become more cautious. In the absence of a global safety net, emerging market economies have accumulated reserves as a form of self-insurance. Over the past few decades, the rapid increase in the volume of financial flows has increased the need to hedge against sudden evaporation or stoppage of international capital flows. Experience from the global financial crisis shows that reserves help emerging market economies navigate fluctuations, with countries with larger reserves experiencing smaller domestic currency depreciation fluctuations (Arslan & Cantú 2019).

While there are benefits to holding foreign exchange reserves as a buffer against sudden drops or drops in international capital flows, there are costs to accumulating foreign exchange reserves. The interest loss from holding assets is a typical cost of holding foreign exchange reserves. Exchange rate risk also arises, when the economy is growing well and the domestic currency appreciates, holding foreign exchange reserves is calculated as a loss, and when the domestic currency depreciates, the reserves are profitable. In addition, accumulating foreign exchange reserves can increase the sense of security and increase the risk tolerance of private enterprises or, from the government's perspective, lead to increased acceptance of risky short-term capital inflows or significant currency misalignments in the long term. In this respect, foreign exchange reserves can be somewhat less effective.

The results of the thesis show that foreign exchange reserves have a supporting effect on Vietnam's monetary policy independence, although the results have not achieved statistical significance in the long term. This can be explained by the fact that the scale of Vietnam's foreign exchange reserves is not large enough to have a strong impact over a long enough period of time to support monetary policy independence. Based on the consideration of the benefits and costs of holding foreign exchange reserves, in the context of

In the context that HNTC still needs to increase, the thesis proposes to continue to increase the scale of foreign exchange reserves further in the following direction:

First , calculating the adequacy of foreign exchange reserves for the economy. There is no single framework for assessing the adequacy of reserves for hedging purposes across countries. Central banks are using a variety of methods to assess the size of reserves needed by comparing the size of accumulated reserves (as a percentage of GDP) against a specific risk. In addition to the traditional method of assessing the adequacy of reserves relative to import needs, a number of methods for calculating the hedging purpose for capital flows are commonly applied depending on the specific characteristics of each country such as the exchange rate regime, the level of HNTC, the depth and liquidity of domestic financial markets (Arslan & Cantú 2019).

 The level of foreign exchange reserves relative to the size of short-term external debt is commonly considered. This method measures the potential debt servicing needs associated with a country's short-term foreign currency borrowing. The Guidotti-Greenspan rule recommends that foreign exchange reserve coverage should be 100% of needs. This rule can be extended to consider the full potential financing needs for 12 months, measured as short-term external debt minus the current account balance.

 Reserves as a percentage of the economy's money supply (M2). This ratio measures the potential demand for foreign assets from domestic sources. This ratio is considered appropriate for countries with developed financial markets and open capital accounts. The benchmark is 20% of M2.

 Combine the demand for short-term external debt and the adjusted M2. Where M2 is adjusted by a ratio of 0.1 for a country with a floating exchange rate regime and 0.2 for a fixed exchange rate regime. In the final calculation, the foreign exchange reserves with coverage should reach 100% of the demand (Wijnholds & Kapteyn 2001).

 Assessing reserve adequacy (ARA): measures potential risks in the balance of payments. The IMF's proposed index has four components:

important components: short-term external debt, M2, export earnings, and other liabilities. The last two components reflect the potential risks from trade shocks and other indirect flows, respectively. This measure is adjusted if the economy is dollarized, implements capital controls, or is a commodity exporter/importer. The benchmark is that foreign exchange reserves cover between 100% and 150% of needs. The weights for each component are based on experience with capital outflows from emerging economies during periods of foreign exchange market stress.

 Measure the optimal level of reserves using a benefit-cost model. This model balances the opportunity cost of holding reserves against the benefit of reducing losses during capital outflows. The optimal level of reserves varies considerably depending on assumptions about output losses, the probability of outflows, and the degree of risk aversion (Jeanne & Rancière 2011).

Due to the characteristics of Vietnam with a tightly managed exchange rate, increasing level of HNTC, and low market depth and liquidity, the thesis proposes to use the method of calculating reserve adequacy based on the ARA measure with four components to be considered: short-term foreign debt, M2, export income and other debts. In addition, it is necessary to calculate the trade-off between the opportunity cost of holding foreign exchange reserves and the benefits achieved according to the benefit-cost model. Combine both methods to choose the reserve level necessary for the country's needs.

Second , consider the composition of foreign exchange reserves. Holding foreign exchange reserves has opportunity costs associated with the type of assets held in reserve. Therefore, reserve managers should consider choosing the type of asset with liquidity appropriate to the needs commensurate with the opportunity cost of that asset. With the goal of being safe from capital flow fluctuations, the type of asset included in the reserve portfolio depends on the currency proportion of short-term foreign loans. According to World Bank statistics (Worldbank 2020) on Vietnam's foreign debt, the currency with the largest proportion is USD, followed by JPY and third is EUR with a much smaller proportion. Therefore, the reserve portfolio must have USD and JPY assets, which can be in the form of foreign currency or other documents.

have a price but must take into account the possibility of conversion in case of emergency and the optimal level of profitability.

5.2.2 For the transmission of Vietnam's monetary policy

In the future, the HNTC process will continue as an inevitable trend, so external developments, especially changes from US monetary policy and risks from the world market, these factors can become factors that control domestic long-term interest rates. The implementation of monetary policy may therefore be limited when facing times of large capital inflows. When capital inflows are large, it also means that the level of risk from the world market decreases, causing long-term interest rates to decrease. On the other hand, when policy interest rates increase along with monetary tightening measures, but because domestic banks and enterprises can access capital flows at lower costs, lending interest rates will not increase along with monetary policy implementation measures. Therefore, in the face of increasing capital flows along with the trend of financial globalization, the SBV needs to make adjustments to its monetary policy framework towards a more diversified approach with many pillars of concern.

5.2.2.1 Designing a monetary policy framework that complements the financial stability mandate

The results of the study on monetary transmission show that Vietnam's long-term interest rates are affected in the same direction as the gradual and long-term increase in global risks and US long-term interest rates. Long-term interest rates are a factor in the transmission of monetary policy to the economy through the interest rate channel. In addition, this is also a fundamental factor in considering the financial stability of a country, the long-term interest rate of government bonds is the center of the valuation of long-term assets. Long-term interest rates as well as other asset prices are increasingly affected by external developments, posing problems for the SBV in responding to credit booms and domestic asset prices during periods of large capital inflows. When financial stability is achieved for a country, it also helps to achieve the price stability goal more easily. Although the SBV has added to the use of traditional monetary policy tools such as policy interest rates, reserve requirements,

... along with capital management tools and macroprudential tools. However, by

The evidence on the effectiveness of these tools to date suggests that macroprudential tools, such as loan-to-value ratios and capital adequacy ratios, can only supplement, not replace, policy interest rate tools. This means that monetary policy also needs to be responsible for financial stability. Therefore, in addition to the long-term price stability objective, the monetary policy framework should pay attention to short-term macroeconomic stability and monitor and address risks related to financial stability. Adding additional policy mandates does not mean abandoning the inflation target; instead, there needs to be an analysis of the benefits and costs related to the priority of the objectives in each period. The macroeconomic stability objective should be relaxed when the issue of financial stability requires more attention or becomes more urgent.

5.2.2.2 Coordinating monetary policy with macroprudential measures

Another lesson learned from the financial crisis and the discussion above is that monetary policy and financial stability policies are intrinsically linked and that a separation or disconnection between monetary and financial stability policies is misguided (Mishkin 2011). As we have seen, monetary policy can affect financial stability, while macroprudential policies aimed at promoting financial stability will have an impact on monetary policy. If macroprudential policies are implemented to contain credit bubbles, they will slow credit growth and slow the pace of aggregate demand. In this case, monetary policy needs to be more accommodative to compensate for weak aggregate demand. Alternatively, if policy rates are kept low to stimulate the economy, there is a risk of credit bubbles. This may require tighter macroprudential policies to ensure that credit bubbles do not develop. Coordination of monetary policy and macroprudential policy becomes more effective when pursuing all three objectives of price stability, output stability and financial stability.

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