Towards improved monetary policy in Indonesia

Abstract

Indonesia's depreciation vastly exceeded that of all other countries hit by the Asian crisis. Indonesia also experienced far higher inflation. This paper argues that there is a close medium to long-term relationship between money growth and inflation in Indonesia, and that this has not been greatly disturbed by the crisis. It argues that the country's disappointing performance in relation to maintaining the value of the rupiah can be explained by the central bank's failure to sterilise the monetary impact on base money of its last-resort lending to the banks. The fundamental lesson is that Bank Indonesia would be well advised to adopt slow and steady growth of base money as the nominal anchor for monetary policy, now that the pre-crisis policy of slow and steady depreciation of the rupiah has been abandoned.

Money - Inflation Nexus in Indonesia: Evidence from a P-Star Analysis

“…Taylor (2000) in his post conference speech at BI suggested the presence of a strong link between the growth of the base money aggregate and the consumer price inflation since the Asian crisis. McLeod (2002McLeod ( , 2003 echoes this observation and suggests that the money-inflation nexus had been present even before the Asian crisis 2 .…”

Survey of recent developments

“…est rates and base money, the final target being inflation) with its one policy instrument, open market operations. The best choice between these two intermediate targets is a matter of controversy that cannot be resolved here (for some of the discussion in the Indonesian context, see McLeod 1997McLeod , 2003McLeod and 2004Grenville 2000;Fane 2000;and De Brouwer 2003). The most important point for present purposes is that either intermediate target will probably work, but its use will entail some volatility in the other, unused, intermediate target.…”

Dealing with bank system failure: Indonesia, 1997–2003

“…The chosen means of achieving this was to substitute a government guarantee of banks' liabilities for last resort loans. Alternatively, it would have been possible to sterilise the monetary impact of last resort lending simply by issuing a similar amount of SBIs (Bank Indonesia Certificates) (McLeod 2003). Enoch et al (2003) assert that 'the authorities [were] unable to sterilise the impact on overall liquidity conditions, [because of] both the lack of effective instruments of monetary control at the time and the authorities' concerns over the impact of high interest rates on the banks ...'.…”

“…Within a few months the currency had appreciated strongly and inflation began to fall rapidly (McLeod 2003). The economy was in deep recession, but output began to stabilise within about six months of Soeharto's departure; nevertheless the debris of the economic and banking collapse was still far from being cleared away by the end of 2003.…”

“…To ward off bank failures the central bank began operating as lender of last resort-before long on a very large scale-but its failure to sterilise the monetary impact of its actions meant that it was supplying the liquidity needed by all those investors who wanted to purchase foreign currency, either to unwind their exchange rate risk exposure or to speculate against the rupiah (McLeod 2003). The upheaval in the foreign exchange market came to be so great that the IMF was called upon for assistance and, as a condition of this support, the government had to accept a number of policy reforms that amounted to direct attacks on the president through his family and cronies.…”