Title : Analysis of Flexible Inflation Targeting Framework: Case Study and Proposed Implementation in Indonesia
Author : Rakhmat
Universitas Airlangga
Item Type : Thesis (Dissertation)
Abstract
The main objective of this study is to examine the monetary policy framework implemented by Bank Indonesia during the implementation of the ITF framework and its impact on macroeconomic indicators, particularly within the context of the monetary policy trilemma. Various challenges have emerged both domestically and internationally during the approximately 15 years of ITF implementation in Indonesia. Nationally, the problem is the presence of structural rigidities on the supply side, which fundamentally disrupt the operation of the policy transmission mechanism. This impact is also felt through pressure on monetary stability. Meanwhile, globally, problems arise related to the impact of the 2008 global financial crisis and the high mobility of short-term capital flows that significantly affect exchange rate developments. Two episodes since the 2008-2009 global financial crisis are specifically analyzed in this study: the period from 2010 to the Fed taper tantrum in May 2013 and the period since the Fed taper tantrum, specifically until 2015. Specifically, there are three findings that can be concluded from this study. First, this study provides empirical evidence that the exchange rate and foreign capital flows have a significant effect on inflation and economic growth, thereby influencing the performance of the ITF in Indonesia. The SVAR model was used to demonstrate the relative influence of external factors (global commodity prices, US monetary policy interest rates, and global risks) on domestic factors in Indonesia (economic growth, monetary policy interest rates, and bank lending rates). This study also found that BI's interest rate reacted to exchange rate shocks and foreign capital flows. This indicates that the exchange rate and foreign capital flows remain important factors in determining monetary policy in Indonesia. Second, this study provides empirical evidence that Bank Indonesia's foreign exchange market intervention policy is primarily motivated by volatility control. This is evidenced by the estimated reaction function of the intervention policy. When the rupiah depreciates, the volatility variable has a positive and significant effect on the reaction of the intervention policy. The effectiveness of Bank Indonesia's intervention policy in stabilizing the rupiah exchange rate has also been empirically proven to be able to control the exchange rate, both in terms of volatility and deviation from its fundamentals. When the exchange rate depreciates, the intervention variable has a negative and significant effect on misalignment. Therefore, it can be concluded that Bank Indonesia's intervention policy is effective in correcting misalignment when the exchange rate depreciates. Third, using a DSGE model that compares the optimal ITF model and actual estimation using Indonesian data with both a single and dual instrument, it can be concluded that the use of interest rate policy in conjunction with foreign exchange market intervention is more effective than using interest rate policy alone. The response to interest rate cuts in the dual instrument model is smaller than in the single instrument model. Inflation and the output gap in the dual instrument model also experienced relatively smaller increases compared to the single instrument model. This finding is consistent with empirical evidence following the 2009 global financial crisis, where Bank Indonesia chose to lower interest rates and purchase foreign exchange during a period of significant capital inflows to mitigate the flood of foreign capital inflows, strengthen the exchange rate, and increase foreign exchange reserves.
Keywords: Inflation Targeting Framework, Exchange Rate, Monetary Policy