FOREIGN TRADE UNIVERSITY

FACULTY OF INTERNATIONAL ECONOMICS

---***---

ECONOMETRICS REPORT

FACTORS AFFECTING INFLATION RATE

Instructor : PhD. Đinh Thị Thanh Bình

Group : 07

Course : KTE309E(GD1-HK1-2223)CTTT.1

Ha Noi, October 2022

 GROUP MEMBERS

Name STT Student ID Contribution (%)

Nguyen Quoc Viet 88 2011140219 25%

Doan Vu Nhat Mai 46 2011140210 25%

Pham Kim Hoa 24 2011140204 25%

Nguyen Phuong Thao 74 2011140217 25%

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ABSTRACT

Under the study of econometric models, the article investigates the effect of the
unemployment rate, GDP growth rate, local exchange rate, and production price index
(PPI) as factors impacting a country’s inflation. When prices for energy, food,
commodities, and other products and services rise during this time, the entire economy
suffers. Inflation affects the cost of living, the cost of conducting business, borrowing
money, mortgages, corporate and government bond rates, and all other aspects of the
economy. The researcher used data collected on each variable from different nations to
operationalize the volatility in the inflation rate. This study, which incorporates data from
estimated models, regression analysis, and diagnosing and addressing problems on the
platform of STATA software, indicates that all four factors have a positive correlation
with the inflation rate. However, the finding also reveals that the unemployment rate is
incompatible with economic theory.

Keywords: Inflation rate, regression model, coefficient

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 TABLE OF CONTENT

CHAPTER 1: INTRODUCTION 5
CHAPTER 2: LITERATURE REVIEW 7
Inflation 7
Factors affecting inflation rate 8
2.1 Unemployment rate 8
2.2 GDP Growth rate 8
2.3 Local exchange rate 9
2.4 Production Price Index (PPI) 9
Research overview 10
3.1 Published relevant studies 10
3.2 Research gap 12
CHAPTER 3: RESEARCH METHODOLOGY AND ECONOMETRICS MODEL 14
Research hypothesis 14
Establish theoretical model 14
2.1 Methods of data collection and processing 14
2.2 Model of theory 15
2.3. Data description 15
2.4. Describe the correlation between the variables 18
CHAPTER 4: QUANTITIES TESTS 20
Estimated model 20
1.1 OLS testing result 20
1.2 Sample Regression Function 20
1.3 Describe and explain the variables used in the regression model 21
Diagnosing and solving problems of the model 21
2.1 Ramsey RESET Test 21
2.2 Multi-collinearity Test 22
2.3 Heteroskedasticity Test 23
2.4 Testing the normality of residual u 26
The results of estimators after solving problems 26
Testing hypothesis of postulated model 27
4.1 Testing statistical significance of regression coefficients 27
4.2 Testing overall significance of the model 28
4.3 Testing the significance of the model with economics theories 28
Result explanation 30
5.1 Meaning of estimators of regression coefficients 30

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 5.2 Determination coefficient (R-squared) 31
5.3 Result analysis 32
CHAPTER 5: CONCLUSION 35

REFERENCES 36

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 CHAPTER 1: INTRODUCTION

In terms of economics, inflation is defined as a rise in the general level of prices of

goods and services in an economy over a period of time. When the price level increases,
each unit of currency buys fewer goods and services. In other words, it can be said that
inflation is a sustained rise in the general price level. The general price level is a value
that reflects the overall price level for goods and services in an economy at a particular
time. A country's economic development as well as the nation itself may be negatively
impacted by inflation in numerous ways. A high inflation rate will increase the living cost
and the living standards of people in a particular country.

One of the most significant macroeconomic variables, and one that economic
factors, including the government, fear the most since it can have a negative impact on
the distribution of income and the structure of production costs, is inflation. Additionally,
broader repercussions like instability, economic expansion, deteriorating competitiveness,
interest rates, unequal income distribution, and unemployment are getting worse. Some of
the nations that have experienced hyperinflation have demonstrated that low inflation
does not promote economic growth but rather social and political unrest.

It may be claimed that over the past few years, literally every nation on earth has
experienced inflation. There are numerous elements that can be employed to explain this
global phenomenon. Either external or economic causes are at blame for this issue.

This research paper will be organized as follows:

● Chapter 1: Introduction

● Chapter 2: Literature review

● Chapter 3: Research methodology and Econometrics model

● Chapter 4: Quantities tests

● Chapter 5: Conclusion

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 Although all the data and information are gathered as well as analyzed carefully,
there are still some mistakes in the report due to a lack of practical knowledge. Our team
is looking forward to receiving feedback from Ms. Dinh Thi Thanh Binh so that we could
complete the research thoroughly.

Also, we would like to thank Ms. Dinh Thi Thanh Binh for the meticulous
instruction during the course. We appreciate everything you have taught us, and we
promise to put out our best effort in this report and on the final exam.

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 CHAPTER 2: LITERATURE REVIEW

1. Inflation

The overall increase in goods prices over the past few decades has been the primary issue
facing the global economy. There were major distortions in the monetary, economic, political,
and social environments as a result of the pressure brought on by rising prices. Inflation is
defined as an increase in prices accompanied by a decrease in the value of money. Hamilton
(2001) said that inflation has been described as an economic situation when the increase in the
money supply is "faster" than the new production of goods and services in the same economy.
Because it has the potential to negatively impact the structure of production costs and the level of
welfare, inflation is one of the most significant macroeconomic variables and the one that
economic actors, including the government, fear the most. Inflation consists of, first, inflation
due to a lack of goods (natural inflation) and second, inflation because of human error caused by
corruption and poor administration, excessive tax policies which implicates burden of farmers
and amount of excessive money.

Inflation can be caused by excess/pull request (liquidity/money/currency) occurs due to

excessive total demand which is usually triggered by a flood of liquidity in the market resulting
in a high demand and trigger changes in the price level. Increasing the volume of the medium of
exchange or liquidity associated with the demand for goods and services resulting in increased
demand for factors of production. The increasing demand for production factors causing prices to
rise. While inflation insistence costs (cost push inflation) occurs due to the scarcity of production
and/or also include the scarcity of distribution. The lack of launch of distribution flow or the
reduction of production provided from the average normal demand could trigger a price increase
in accordance with the legal validity of the demand - supply.

Inflation is the main factor of economic crisis, discourages investments and determines
the migration of capital to other countries or real estates. The broken equilibrium created by
inflation strongly affects the decisions of the private sector to invest or develop, with the final
effects in decreasing production and stagnation. The wider effects such as instability, economic
growth, the declining competitiveness, the interest rate, uneven income distribution and
unemployment are increasing. Some of the countries that have experienced hyperinflation

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showed that poor inflation would lead to social and political instability, and did not create
economic growth.

2. Factors affecting inflation rate

The determinants of inflation are very much important in building economic forecasts in
planning models and in several sectors although the factors change from country to country
instead of some general variables. Even the relationship changes from one period to another
which was found in many econometric studies. Those factors are very diverse and action into the
national economy and from external sources. From the large number of known inflation
influence factors, we tried to endeavor to locate some determinants of inflation in some countries
such as Unemployment rate, GDP growth rate, Local exchange rate, and Producer Price Index.

2.1 Unemployment rate

When there is a greater demand for labor than there are available positions, economists
refer to this scenario as unemployment. The relationship between unemployment and inflation
has historically been inverse. One causes the other to fall when it rises and vice versa. To prevent
overstimulating or excessive slowdown of the economy, governments often rely on monetary and
fiscal policy. It makes sense that these two things are connected. When unemployment is low,
there are more jobs needed than there are workers to fill them. Simply said, there are more open
positions than there are open positions. On the other side, when unemployment increases, there
are far more job seekers than there are open positions. This is so even while more people wish to
find employment, few firms are really employing.

2.2 GDP Growth rate

Gross domestic product (GDP) is the total monetary or market value of all the finished
goods and services produced within a country’s borders in a specific time period. As a broad
measure of overall domestic production, it functions as a comprehensive scorecard of a given
country’s economic health. The calculation of a country’s GDP encompasses all private and
public consumption, government outlays, investments, additions to private inventories, paid-in
construction costs, and the foreign balance of trade. (Exports are added to the value and imports
are subtracted).

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GDP Growth Rate is also known as the Economic Growth Rate, and it measures the change in
the GDP of the country in comparison to an earlier period. The amount of change is measured in
percentage (%), which serves as a determinant of economic health in the country and the possible
growth in the future. The GDP of a certain period, when set against another, can show a
comparison that can be measured using the given formula:

Economic Growth = (GDP2 - GDP1) / GDP1

The result is expressed in a percentage. If the result is positive, it means the economy is
growing by the said percent. If the growth rate is 2 percent from the previous quarter to now, it
means that the economic activity has risen by 2%, either due to increased Government
expenditure, higher retail consumption or in exports and imports.

2.3 Local exchange rate

An exchange rate is a rate at which one currency will be exchanged for another currency
and affects trade and the movement of money between countries. Exchange rates are impacted by
both the domestic currency value and the foreign currency value. The exchange rate between two
currencies is commonly determined by the economic activity, market interest rates, gross
domestic product, and unemployment rate in each of the countries. Commonly called market
exchange rates, they are set in the global financial marketplace, where banks and other financial
institutions trade currencies around the clock based on these factors. Changes in rates can occur
hourly or daily with small changes or in large incremental shifts. Exchange rates can be
free-floating or fixed. A free-floating exchange rate rises and falls due to changes in the foreign
exchange market. A fixed exchange rate is pegged to the value of another currency.

2.4 Production Price Index (PPI)

The producer price index (PPI) measures the average change over time in the prices
domestic producers receive for their output. It is a measure of inflation at the wholesale level that
is compiled from thousands of indexes measuring producer prices by industry and product
category. The PPI measures inflation (or, much less commonly, deflation) from the perspective of
the product manufacturer or service supplier. The price trends for producers and consumers are
unlikely to diverge for long since producer prices heavily influence those charged to consumers

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and vice versa. In the short term, inflation at the wholesale and retail levels may differ as a result
of distribution costs, as well as government taxes and subsidies. The PPI is used to forecast
inflation and to calculate escalator clauses in private contracts based on the prices of key inputs.
It is also vital for tracking price changes by industry and comparing wholesale and retail price
trends.

3. Research overview

3.1 Published relevant studies

A study by Y. Yolanda (European Research Studies Journal Volume XX, Issue 4B, 2017):
Analysis of Factors Affecting Inflation and its Impact on Human Development Index and
Poverty in Indonesia

This study was conducted to determine the factors that influence inflation and how the
effect of inflation on the Human Development Index (HDI) and poverty in Indonesia for the
period 1997 up to 2016. In determining the factors influencing inflation, they are based on the
theory of demand-pull inflation and supply-side inflation, then conduct research on those factors
that are Bank of Indonesia (BI) rate, Money Supply, exchange rate, oil prices, and the price of
gold. This study used secondary data with a purposive sampling method to discuss 3 regression
models. Model 1 is the relationship between BI Rate, Money Supply, World oil price, and gold
price with inflation, on the other hand, inflationary relationship with HDI and Poverty in
Indonesia. The findings reveal that the variable BI rate, Exchange rate, World oil Price and Gold
Price to Inflation is positive and significant. While the Variable Amount of Money Supply to
inflation is significant and negative. Model 2 refers that inflation has a significant and positive
effect on HDI and model 3 refers that inflation has a significant and positive effect on poverty in
the long term.

The analysis's findings demonstrated that while the exchange rate is not a factor in the
rate of inflation, other variables such as the money supply, oil price, and gold prices have some
positive and significant effects on the level of inflation.

According to these results, inflation affects all economic activity and is a disease of the
economy. In accordance with additional study findings, the variables under investigation have a

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considerable impact on the rate of inflation, therefore the government may utilize these findings
to make decisions about its monetary and fiscal policies.

A study by Dr.Debesh Bhowmik (International Journal of Scientific and Research

Publications, Volume 5, Issue 2, February 2015): An Econometric Model of Inflation in India

The article showed that the inflation model in India is cointegrated in the order I(1) when
GDP growth rate, degree of openness, money supply growth rate, Rupee exchange rate in
relation to the US dollar, budgetary deficit as per percent of GDP, the interest rate (lending rate),
and the price of crude oil US$/barrel are all taken into account. In order to conduct the above
data, the author applied cointegration and VECM methodology to relate growth of Consumer
Price Index. From 1970 until 2013, the Johansen cointegration test revealed that: according to
trace data, there is one cointegrating vector and according to λmax statistics, there are two
cointegrating vectors. The VECM demonstrated that the inflation rate is related to interest rates.
Rate with a one-period lag and the prior period's inflation rate linked with the pace of GDP
growth and the expansion of the money supply significantly. The VECM demonstrated that the
inflation rate is related to the interest rate with a one-period lag, and the prior period inflation
rate is linked with the pace of GDP growth and the expansion of the money supply significantly.
The same conclusion was reached in the VAR model, however in the double log linear model, a
1% increase in CPI each year reduced the growth rate of GDP in India by 0.058% per year
between 1961 and 2011. According to VECM, the calculated equation 1 adjusts its inaccuracy by
23%, whereas equation 2 adjusts by 14%. Inside equations 3 and 7, respectively, by 34% and
71% within one year, while other formulae alter insignificantly.

As stated by Dr.Debesh Bhowmik, with the econometric model concerned, the policy
implications of this econometric model should focus on optimal monetary policy, flexible
interest rate policy, and obtaining greater growth rates, which may be used to reduce inflation in
the long run. Furthermore, oil price stability and currency rate stability should be important
policy objectives for controlling inflation in India. One limitation in the research that could be
mentioned is that it only studies macro econometric models of inflation whereas micro
determinants have a lot to concern.

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A study by Falnita, Eugen and Sipos, Ciprian (Munich Personal RePEc Archive Paper;
No.2011473; 2008): A multiple regression model for inflation rate in Romania in the enlarged
EU

This paper necessitates the development of a model that studies the trend of the
inflationary process as a result of the most significant influence factors, such as the labor market,
the Romanian Leu exchange rate, interest rates, the Production Price Index (PPI), Monetary
Policy - Broad Money (M2), and Non-government Credit. The author initially examines these
components using the one-factor regression model to evaluate whether they are statistically
significant or not by looking at the Multiple R and estimated coefficients as well as utilizing the
F-test and t-test. As a result, the CPI (inflation) has strong links with all of the above. All of these
factors are taken into account when developing traditional multiple regression models with
standard parameters for Romania in the larger European Union. In this section, the author
discusses and interprets the calculated coefficients (both positive and negative). Taking into
account all of the influencing elements included in the multiple regression model, the evolutions
of CPI and model-based anticipated CPI are provided, demonstrating the greater predictability of
inflation rate in the recent periods extremely near to or following membership to the European
Union. The author continues by suggesting that after Romania joins the European Union,
beneficial improvements in trade and pricing levels may occur.

One important weakness of this study is its small sample size, with just 29 monthly
observations after correcting for endpoints, suggesting that the results may have limited
statistical power. The second issue is a lack of precise hypotheses and diagnostic tests, as well as
solutions to probable problems. This can pose significant dangers since a country's economic
policy making and the development of economic theory both rely on empirical analysis for
direction and sustenance. As a result, more systematic testing of empirical models should and
may significantly enhance the quality of recommendations received from this applied
econometric research.

3.2 Research gap

Despite mentioning the factors that determine inflation, Dr.Debesh Bhowmik's study
makes no reference to how these factors actually affect the inflation rate. It just clarifies the

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changes of CPI and GDP brought on by those elements. This leaves the study's conclusion quite
unclear and ambiguous.

The other two studies, which are by Y. Yolanda, and by a group of two authors Falnita
Eugen and Sipos Ciprian, are all conducted with outdated data and information. To be more
specific, while the research of Y. Yolanda was conducted in 2017, the other one has the latest
data in 2007.

Moreover, those three studies examine the inflation data in separate countries over
different periods of time. This causes some conflict and inconsistency in the range of influencing
factors and how they make changes on inflation.

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 CHAPTER 3: RESEARCH METHODOLOGY AND ECONOMETRICS MODEL

1. Research hypothesis

The study team discovered that, as previously noted, there are still gaps in the hypotheses
and past investigations. As a result, the team would like to present further research on the
variables influencing inflation rates in 14 different nations. From a preliminary analysis, the main
influence factors of the inflation rate in those countries are the following independent variables:
GDP Growth Rate, Local Exchange Rate, Production Price Index (PPI), and Unemployment
Rate. The inclusion of a representative element of the number of nations input into the model,
rather than focusing on just one nation, is novel in the study, as is diagnostic testing of the model,
which was rarely done in earlier studies.

2. Establish theoretical model

2.1 Methods of data collection and processing

a. Data collection method

To run the model and make this report, our team collected secondary data samples from
178 observations of GDP growth rate, local exchange rate, production price index (PPI), and
unemployment rate from 14 countries to observe the influence of those factors on inflation from
2010 to 2021. The model's data is panel data, collected by statistical methods with high-precision
online data sources which are World Bank, OECD, Federal Reserve Bank of St. Louis, Statista,
WorldData, and MacroTrends.

b. Data processing method

The data were chosen by calculating the ordinary least squares (OLS), coefficients and
the statistical significance of the regression coefficients. The form of ordinary least squares is
attributed to Carl Frieddrich Gauss, a German mathematician. Under certain hypotheticals, the
form of least places has some captivating statistical lots that have made it one of the most
heavy-duty and popular forms of retrogressions analysis, for it has a non-casual direct
dispassionate estimator.

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 To summarize and finalize this work, our team employed understanding of econometrics,
macroeconomics, and quantitative approaches with the use of STATA software, Microsoft Excel,
and Microsoft Word.

2.2 Model of theory

Our team decided to use multiple regression analysis to find out the dependence of the
dependent variable on inflarate for 4 independent variables including gdpgrr, lexchrate, urate,
and ppi.

Lninflarate = β0 + β1𝑙𝑛gdpgrr + β2𝑙𝑛lexchrate + β3lnurate + β4lnppi + 𝑢𝑖

β0: The estimate of intercept factor

β1: The estimate of the slope of the variable lngdpgrr

β2: The estimate of the slope of the variable lnlexchrate

β3: The estimate of the slope of the variable lnurate

β4: The estimate of the slope of the variable lnppi

𝑢𝑖 : residual, estimate of random errors

2.3. Data description

a. Data source

After a preliminary analysis, the main influence factors of the inflation rate in those
countries are the following independent variables: GDP growth rate, oil price, Production Price
Index (PPI), and unemployment rate.

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 The table below details our group report utilizing the variation measuring approach.
Furthermore, we acknowledge that this sample size is large, objective, and trustworthy enough to
support the development of a regression model.

Variable Definition Unit Measure Source

inflarate Inflation rate % The GDP deflator annual year World Bank ;
World Data

gdpgrr GDP growth rate % The year-over-year change in a Macrotrend

country's economic output to
measure how fast an economy
is growing

lexchrate Local exchange LCU The Period average rate and World Bank
rate per US$ usage rate, including all
necessary and attendant
charges, imposed for basic
local exchange service to
customers

urate Unemployment % The percentage of the labor World Bank

Rate force without a job in a year

ppi Producer Price % The average change over time Economy.com ;

Index (2015 = in the selling prices received by OECD; Statista
100) domestic producers for their ; Federal
output. Reserve Bank
of St. Louis

The dimension of data collected covers 14 different countries of different continents and
currencies, consisting of Vietnam, Thailand, China, Colombia, Korea, USA, Russia, Germany,

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France, South Africa, Japan, Australia, Norway, Poland, and Turkey, and the time span ranges
from 2010 to 2021.

With the data of the table, the number of observations has increased and updated
compared to the previous published table.

b. Description of statistics

To provide the best overview as well as initiate some initial judgments, our team will
describe the data before going deeply in the data analysis. Through this description, our team can
predict some errors that may occur when running the model due to the lack of data.

We first use “GEN” command to generate variables “inflarate”, “gpdgrr”, “lexchrate”,

“urate”, “ppi”, then running the command “SUM” to get details about all the variables, including
their Obs (number of observations), Mean (average value), Std.Dev. (standard deviation), Min
(minimum value), Max (maximum value) in the table below:

Table 1.1

From table 1.1, we have:

● “inflarate” variable represents Inflation rate, unit: %, has 178 observations, mean
3.21809, standard deviation 3.365785, minimum -0.9, maximum 19.6.

● “gdpgrr” variable represents GDP growth rate, unit: %, has 178 observations, mean
2.912865, standard deviation 3.082772, minimum -7.9, maximum 11.2

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 ● “lexchrate” variable represents Local exchange rate, unit: LCU per US$, has 178
observations, mean 1719.081, standard deviation 5393.753, minimum 0.97, maximum
23208.37.

● “urate” variable represents Unemployment rate, unit: %, has 178 observations, mean
6.718595, standard deviation 5.51508, minimum 0.3, maximum 28.8.

● “ppi” variable represents Producer Price Index, unit: %, has 178 observations, mean
104.8722, standard deviation 20.99798 , minimum 67.1, maximum 298.2.

Based on the model, our team will use the Gen command to get the natural logarithm of the all
variables and name the variable respectively “lninflarate”, “lngdpgrr”, “lnlexchrate”. “lnurate”,
“lnppi” as Table 1.2.

Table 1.2

As can be seen from the table, the number of observations reduces in comparison to Table 1.1.
This is due to the fact that there are some negative observations which are not included.

2.4. Describe the correlation between the variables

Running the command “CORR” to analyze the correlation between the variables, we
have the table of correlation as below:

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 Table 2. Correlation matrix between model variables

There is only two levels of correlation between the independent factors and the dependent
variable, which is low and near-medium. “lnurate” is the variable with the highest correlation
(0.3225).

● r(lninflarate, lngdpgrr) = 0.1633: the degree of correlation between Inflation rate and
GDP growth rate is low (16.33%), the correlation coefficient is positive, the relationship
between “lninflarate” and “lngdpgrr” is positive.

● r(lninflarate, lnlexchrate) = 0.1269: the degree of correlation between Inflation rate

and Local exchange rate is low (12.69%), the correlation coefficient is positive, the
relationship between “lninflarate” and “lnlexchrate” is positive.

● r(lninflarate, lnurate) = 0.3225: the degree of correlation between Inflation rate and
local exchange rate is near-medium (32.23%), the correlation coefficient is positive, the
relationship between “lninflarate” and “lnurate” is positive.

● r(lninflarate, lnppi) = 0.1552: the degree of correlation between Inflation rate and Local
exchange rate is low (15.23%), the correlation coefficient is positive, the relationship
between “lninflarate” and “lnppi” is positive.

Thus, the correlation coefficient between the independent variables has the mean value,
does not come close to 1 or -1, there is no absolute correlation between the independent
variables.

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 CHAPTER 4: QUANTITIES TESTS

1. Estimated model

1.1 OLS testing result

In STATA, by using reg lninflarate lngdprr lnlexchrate lnurate lnppi, we have result as
below:

Table 3

1.2 Sample Regression Function

From the above result we have Sample Regression Function:

lninflarate = -3.350463 + 0.1870049lngdpgrr + 0.0584007lnlexchrate + 0.4246856lnurate +

0.6955721lnppi + 𝑢𝑖

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 1.3 Describe and explain the variables used in the regression model

Sign of
Variable Judgment
expectation

Intercept coefficient (--)

The higher inflation will increase GDP in terms of

GDP growth rate (+)
money value

If a country has the higher exchange rate (per US$), it

Exchange rate (+)
has the higher inflation rate

Unemployment rate (+) The higher unemployment rate means high inflation

If inflation rate is expected to rise, producers often

PPI (+) have to charge higher prices to compensate for rising
costs

● Sign (+): the positive relationship to the inflation rate

● Sign (--): the negative relationship to inflation rate

2. Diagnosing and solving problems of the model

2.1 Ramsey RESET Test

Set up hypothesis 𝐻0, 𝐻1:

● 𝐻0: The model does not have misspecification of important variables

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 ● 𝐻1: The model has misspecification of important variables

In STATA, by using ovtest, we have the result:

● Prob > F = 0.5795 is greater than 5%

● At a significant level of 5%, we can accept hypothesis 𝐻0

Conclusion: The model does not have misspecification of important variables.

2.2 Multi-collinearity Test

Set up hypothesis 𝐻0, 𝐻1:

- 𝐻0: The model does not exist multicollinearity

- 𝐻1: The model exists multicollinearity

In STATA, by using vif, we have the result:

Table 4

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From the above result, we can refer that:

- VIF (lnlexchrate) = 1.18 < 10

- VIF (lnurate) = 1.14 < 10

- VIF (lngdpgrr) = 1.08 < 10

- VIF (lnppi) = 1.01 < 10

Because the VIF of the 4 variables and Mean VIF are smaller than 10 => Hypothesis 𝐻0 is

accepted.

Conclusion: The model does not exist multicollinearity at a significant level of 5%.

2.3 Heteroskedasticity Test

Set up hypothesis 𝐻0, 𝐻1:

- 𝐻0: The model has homoskedasticity

- 𝐻1: The model has heteroskedasticity

In STATA, by using imtest, white , we have the result:

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 Table 5.1

- As P-value = 0.0000 is lower than 5%, hence, at a significant level of 5%, we reject
hypothesis 𝐻0 and accept hypothesis 𝐻1.

=> The model has heteroskedasticity at a significant level of 5%.

To have a more accurate result, we also use hettest in STATA and have the result:

- As P-value = 0.2141 is greater than 5%, hence, at a significant level of 5%, we accept
hypothesis 𝐻0 and reject hypothesis 𝐻1.

=> The model does not have heteroskedasticity at a significant level of 5%.

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Conclusion: By using two different tests (White test and Breusch- Pagan test), we have different
results. However, we have to use White test as it has heteroskedasticity at a significant level of
5%.

Consequence: When the model has heteroscedasticity, the estimators are still linear and
unbiased, but not the best.

The variance of the coefficient will be biased, making the standard error (se) biased, resulting in
the inaccuracy of the hypothesis test.

Solution: Using Robust Standard Error Method

In STATA, by using reg lninflarate lngdpgrr lnlexchrate lnurate lnppi, robust, we have

the result:

Table 6

From the above result, we can refer that:

After using Robust Standard Error Method, coefficients of given variables and R-squared =
0.2140 remain unchanged. There is only a change in standard error which leads to the change in

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t, P-value and confidence interval. Therefore, we have to use the new value of t, P-value and
confidence interval from the above table to do the test regression coefficient.

2.4 Testing the normality of residual u

Set up hypothesis 𝐻0, 𝐻1:

- 𝐻0: Residuals u has normal distribution

- 𝐻1: Residuals u does not have normal distribution

In STATA, by using predict u, residuals and sktest u, we have the result:

Table 7

- As P-value = 0.4932 > 5% => At a significant level of 5%, we can not reject hypothesis
𝐻0

Conclusion: Residuals u of the model have normal distribution at significant level of 5%.

3. The results of estimators after solving problems

After testing and fixing the problems of heteroscedasticity, the group decides to keep the
regression function as initial:

lninflarate = -3.350463 + 0.1870049lngdpgrr + 0.0584007lnlexchrate + 0.4246856lnurate +

0.6955721lnppi + 𝑢𝑖

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However, our group is going to use the new values of t, P-value and interval confidence in Table
6 to do the hypothesis test of the model in Table 4.

4. Testing hypothesis of postulated model

4.1 Testing statistical significance of regression coefficients

Set up hypothesis 𝐻0, 𝐻1:

- 𝐻0: Regression coefficients of independent variables do not have statistical significance

(βj=0)

- 𝐻1: Regression coefficients of independent variables have statistical significance (βj≠0)

Based on the result of postulated model, we have

- Constant coefficients: P-value ≈ 0.108 > 0.05 → Do not reject 𝐻0

Therefore, regression coefficients of constant coefficients do not have statistically significant

effects on lninflarate at the 0.05 level.

- Variable lngdpgrr: P-value ≈ 0.016 < 0.05 → Reject 𝐻0

Therefore, regression coefficients of variable lngdpgrr have statistically significant effects on

lninflarate at the 0.05 level.

- Variable lnlexchrate: P-value ≈ 0.005 < 0.05 → Reject 𝐻0

Therefore, regression coefficients of variable lnlexchrate have statistically significant effects on

lninflarate at the 0.05 level.

- Variable lnurate: P-value ≈ 0.000 < 0.05 → Reject 𝐻0

Therefore, regression coefficients of variable lnurate have statistically significant effects on

lninflarate at the 0.05 level.

27
 - Variable lnppi: P-value ≈ 0.118 > 0.05 → Do not reject 𝐻0

Therefore, regression coefficients of variable lnppi do not have statistically significant effects on
lninflarate at the 0.05 level.

Conclusion: After using the P-value testing method to examine statistical significance of
regression coefficients, we can confirm that regression coefficients of independent variables,
except PPI, have statistically significant effects on Inflation rate at the 0.05 level.

4.2 Testing overall significance of the model

Set up hypothesis 𝐻0, 𝐻1:

- 𝐻0: β1 = β2 = β3 = 0 (All independent variables do not explain for any value of dependent

variables)

2 2 2
- 𝐻1: β1 + β2 + β3 ≠ 0

Or:

2
- 𝐻0: 𝑅 = 0

2
- 𝐻1: 𝑅 ≠ 0

Based on the postulated result of the model, we have Fs= 11.81 > 𝐹5%(4; 149) = 2.43.

→ Reject 𝐻0

Conclusion: At a significant level of 5%, the model has overall significance.

4.3 Testing the significance of the model with economics theories

a. With lngdpgrr

Set up hypothesis 𝐻0, 𝐻1:

28
 - 𝐻0: β1 = 0

- 𝐻1: β1 > 0

We have 𝑡α = 𝑡0.05149 ≈1. 976

Because |ts|= 2.45 > 𝑡α = 1. 976 → Reject 𝐻0

Conclusion: At the significant level of 5%, ceteris paribus, the regression coefficient

of lngdpgrr is positive, it is suitable with the economic theory that inflation rate will

increase when the GDP growth rate increases.

b. With lnlexchrate

Set up hypothesis 𝐻0, 𝐻1:

- 𝐻0: β2 = 0

- 𝐻1: β2 > 0

We have 𝑡α = 𝑡0.05149 ≈1. 976

Because |ts| = 2.83 > 𝑡α = 1. 976 → Reject 𝐻0

Conclusion: At the significant level of 5%, ceteris paribus, the regression coefficient of
lnlexchrate is positive, it is suitable with the economic theory that inflation rate will increase
when foreign exchange rate increases.

c. With lnurate

Set up hypothesis 𝐻0, 𝐻1:

- 𝐻0: β3 = 0

29
 - 𝐻1: β3 > 0

We have 𝑡α = 𝑡0.05149 ≈1. 976

Because |ts| = 5.24 < 𝑡α = 1. 976 → Reject 𝐻0

Conclusion: At the significant level of 5%, ceteris paribus, the regression coefficient of
lnlexchrate is positive, it is unsuitable with the economic theory that inflation rate will drop
when Unemployment rate increases.

d. With lnppi

Set up hypothesis 𝐻0, 𝐻1:

- 𝐻0: β3 = 0

- 𝐻1: β3 > 0

We have 𝑡α = 𝑡0.05149 ≈1. 976

Because |ts| = 1.57 < 𝑡α = 1. 976 → Cannot reject 𝐻0

Conclusion: At the significant level of 5%, PPI has no statistically significant effect on inflation
rate.

5. Result explanation

5.1 Meaning of estimators of regression coefficients

β0= -3.350463 (Estimation for constant coefficient): When all independent variables equal 0, the

expected value of the inflation rate will be -3.350463%.

30
β1= 0.1870049 (Estimation for the regression coefficient of GDP growth rate): When all

independent variables remain unchanged, the expected value of the GDP growth rate will
increase by 0.1870049 % if inflation rate increases by 1 unit.

β2= 0.0584007 (Estimation for the regression coefficient of local exchange rate): When all

independent variables remain unchanged, the expected value of local exchange rate will increase
by 0.4246856 % if inflation rate increases by 1 unit.

β3= 0.4246856 (Estimation for the regression coefficient of unemployment rate): When all

independent variables remain unchanged, the expected value of unemployment rate will increase
by 0.4246856 % if inflation rate increases by 1 unit.

β4= 0.695721 (Estimation for the regression coefficient of producer price index): When all

independent variables remain unchanged, the expected value of producer price index will
increase by 0.695721% if inflation rate increases by 1 unit.

5.2 Determination coefficient (R-squared)

2
Determination coefficient 𝑅 = 0.2140 means that the independent variables (GDP
growth rate, Local exchange rate, Unemployment rate, Producer price index) can explain 21.40%
of the sample variation of inflation rate.

2
Besides, we also consider adjusted 𝑅 , as when adding new variables in the model,
2 2
despite its significance, 𝑅 increases. The increase of 𝑅 will increase the explanatory power of
the model but cannot clarify the importance of the input variable, resulting in the incorrectness of
2
the model. Therefore, adjusted 𝑅 is used to determine the variables.

2
Adjusted 𝑅 is calculated as following:

𝐸𝑆𝑆
2 𝑛−𝑘−1 𝑛−1 2
𝑅 = 1− 𝑇𝑆𝑆 =1 − 𝑛−𝑘−1
(1 − 𝑅 )
(𝑛−1

31
 In which:

n: number of observation

k: number of independent variable

2
𝑅 : determination coefficient

2
From the above formula, we can calculate 𝑅 = 0.1929. That means independent
variables can explain 19.29% the sample variation of dependent variable, the remaining 80.71%
is explained by variables outside the model.

5.3 Result analysis

According to our researching result, we can conclude that:

● As GDP growth rate increases, inflation rate increases and vice versa, ceteris paribus.

● As local exchange rate increases, inflation rate increases, and vice versa, ceteris paribus.

● As the unemployment rate increases, inflation rate increases and vice versa, ceteris
paribus.

● As the producer price index increases, inflation rate increases and vice versa, ceteris
paribus.

Meanwhile, the postulated estimation results indicate that:

● Regression coefficient estimator of lngdpgrr is β1= 0.1870049

● Regression coefficient estimator of lnlexchrate is β2= 0.0584007

● Regression coefficient estimator of lnurate is β3= 0.4246856

● Regression coefficient estimator of lnppi is β4= 0.695721

32
Therefore, all regression model results, except for unemployment rate, are consistent with
economic theories.

Concerning GDP growth, it's clear inflation and GDP growth go hand-in-hand (Hall,
2021):

● Scenario 1: To satisfy rising demand, production is being boosted. Higher output leads to
a reduced unemployment rate, which fuels demand even more. Wage increases contribute
to increased demand as people spend more freely. This results in greater GDP and
inflation.

● Scenario 2: There is no rise in customer demand, yet prices are greater. In this scenario,
both GDP and inflation rise. These rises are the result of decreased supply of critical
commodities and rising consumer expectations, rather than increased demand.

● Scenario 3: There is both growing demand and a supply shortfall. Businesses must recruit
more workers, creating demand by raising pay. Increased demand in the face of limited
supply swiftly drives up costs. In this scenario, GDP and inflation both rise at
unsustainable rates that policymakers find impossible to influence or control.

● Scenario 4: This is quite similar to what occurred in the United States in the 1970s and is
commonly referred to as stagflation. GDP grows slowly and at a lower rate than
expected, yet inflation continues and unemployment stays high due to poor output.

Concerning local exchange rate, the exchange rate affects the rate of inflation and
economic growth. When the exchange rate increases, the price of imported goods becomes more
expensive, increasing the rate of inflation. Conversely, a falling exchange rate means an increase
in the local currency, cheaper imported goods, and moderate inflation.

Concerning the unemployment rate, we state that it does not align with any economic
theory. However, we can possibly say that it is due to the fact that our sample is derived from
countries that are highly developed, thus low unemployment rate and the following scenario can
happen: When employment is at or near its lowest point. Extremely low unemployment rates

33
have shown to be more costly than helpful since a near-full employment economy causes two
crucial things to happen (Barnes, 2021):

1. Prices will rise when aggregate demand for goods and services rises faster than supply.

2. As a result of the tight labor market, businesses will have to hike salaries. As the
corporation seeks to maximize profits, this increase is frequently passed on to customers
in the form of increased pricing.

This, over time, causes the growth in GDP, resulting in a rise in inflation, as previously
analyzed in the first place. If inflation is not controlled, it has the potential to become
hyperinflation. Once in place, this process may soon create a self-perpetuating feedback loop.
This is because, in an inflationary environment, individuals will spend more money because they
expect it to be less valuable in the future. This promotes more short-term rises in GDP, resulting
in further price increases.

Concerning producer price index, we may claim that the PPI and the inflation rate are
statistically significant, but we cannot assume that if the PPI rises, the inflation rate would rise as
well. The producer price index (PPI) does, in fact, evaluate inflation from the standpoint of costs
to industry or product manufacturers.

34
 CHAPTER 5: CONCLUSION

Generally, inflation is caused by the fall in aggregate supply to equal the increase
in aggregate demand. It can be controlled by increasing the supplies of goods and
services and reducing money incomes in order to control aggregate demand. High
inflation may cause a negative impact on a particular country. This research paper
discussed and analyzed four factors which are the GDP growth rate, foreign exchange
rate, Unemployment rate, and PPI by utilizing the regression model. We collected the
dataset of those factors indicators on credible websites. We used annual data for the
period from 2010 to 2021 to know the exact impact of those factors to the price level. The
results show that while the relationships between GDP growth rate, foreign exchange
rate, unemployment rate and inflation are positive, PPI has no statistically significant
effect on the inflation rate. In addition, it can be seen as there are more factors that can be
affecting inflation as the R-square value is insignificant. It means that the three factors
that have been discussed in this research, are just a part of the factors that influence
inflation throughout the world.

These findings indicate that inflation is a disease in the economy of a country that
brings impacts to all economic activities. Another number of research results stated that
the variables studied significantly influence the rate of inflation meaning that these
studies can be used by the government in determining fiscal and monetary policy to
control inflation.

35
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