Title : Analysis of Flexible Inflation Targeting Framework : Case Study and Application Proposal in Indonesia
Author : Rakhmat
Universitas Airlangga
Item Type : Thesis (Dissertation)
Abstract
The main objective of this research is to examine the monetary policy framework implemented by Bank Indonesia during the period of implementation of the ITF framework and how it influences macroeconomic indicators, especially in the context of the monetary policy trilemma. Various challenges have emerged both from within and outside the country during the approximately 15 years of ITF implementation in Indonesia. In the national scope, the problem that occurs is the existence of structural stiffness on the supply side, which fundamentally disrupts the working of the policy transmission mechanism. The impact is also felt through pressure on monetary stability. Meanwhile, in the global sphere, problems emerged related to the influence of the global financial crisis in 2008 and the high mobility of short-term fund flows which greatly influenced exchange rate developments. Two episodes since the 2008-2009 global financial crisis in particular were analyzed in this research, namely the period from 2010 to the Fed taper tantrum in May 2013 and the period since the Fed taper tantrum in particular until 2015. In particular, there are three findings that can be concluded from this research. First, this research 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 is used to prove the magnitude of 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 credit interest rates) . This research also found that BI interest rates react to exchange rate shocks and foreign capital flows. This indicates that the exchange rate and foreign capital flows are still factors to be considered in determining monetary policy in Indonesia. Second, this research provides empirical evidence that the foreign exchange market intervention policy carried out by Bank Indonesia is based more on the motive of controlling volatility. This is proven by the results of estimating the reaction function of intervention policies. When the rupiah exchange rate experiences depreciation, the volatility variable has a positive and significant effect on the reaction to intervention policies. 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 at the level of volatility and deviation of the exchange rate from its fundamentals. When exchange rate depreciation occurs, the intervention variable has a negative and significant effect on misalignment. So it can be concluded that Bank Indonesia's intervention policy is effective in correcting misalignment when the exchange rate experiences depreciation. Third, by using the DSGE model which compares the optimal ITF model and actual estimation using Indonesian data with single instruments and dual instruments, it can be concluded that the use of interest rate policy together with foreign exchange market intervention is more effective than just using interest rate policy. The response to a decrease in interest rates on dual instruments is smaller than on single instruments. Inflation and output gap on dual instruments also experienced relatively smaller increases compared to single instruments. This finding is consistent with empirical evidence in the aftermath of the 2009 global financial crisis where Bank Indonesia chose to lower interest rates and buy foreign currency when there was a very large capital inflow to reduce the flood of foreign capital inflows and strengthen the exchange rate and increase foreign exchange reserves.
Keywords: Inflation Targeting Framework, Exchange Rate, Monetary Policy
