Finally Bank Indonesia raised its rate by 25 basis points, after successfully maintaining a 6.5 percent policy rate since August 2009, which was a tremendous record in the history of Indonesia’s economy and mone-tary stance.
The central bank argued that there was an increase of expected inflation in the future, stimulated by a rise in global commodity prices, particularly extractive good prices (e.g. oil and coal), as well as the
government’s plan to raise the gasoline price for the majority of fuel consumers by limiting private cars’ access to subsidized fuel in April this year.
Generally, most central banks across the world, including Indonesia, have been implementing the standard interest rate and balance sheet channels of monetary policy in response to global financial crisis. The poole analysis confirmed that if financial markets are more unstable than good markets, then the central bank can best minimize the fluctuations of the business cycle (e.g. the real GDP and inflation rate) by using the interest rate as the instrument of monetary policy.
Nevertheless, our financial markets are in the shape of condition, considering the fact that the composite stock price index (IHSG) seemed to rebound in the peaked point of 3,500 basis points, given a one-off negative sentiment of the regional market in the wake of Egypt’s political instability.
In terms of exchange rate policy, although the rupiah had been weakened as a result of temporary capital outflow, caused by concerns of market on rising inflationary pressures, foreign investors are now back by noting the value of net purchases amounted to Rp 215.64 billion (US$24.2 million) from the total purchase value of Rp 1.94 trillion.
Meanwhile, the Central Bureau of Statistics (BPS) recorded a year-on-year inflation rate in January 2011 that reached 7.02 percent, in which a rise in staple food prices contributed dominantly.
Based on the arguments, the financial markets looks more stable than good markets and therefore, it is better for the central bank to use money supply or the so-called quantitative approach as an instrument of its monetary policy. And, the central bank last month launched measures to tighten liquidity in the economy by increasing the statutory reserve requirement, lengthening the tenure of Bank Indonesia Certificates (SBIs) and imposing restrictions on banks’ short-term external borrowing.
Here, we still see the credibility of bank Indonesia in a sense that the central bank sticks to its decisions about monetary policy and makes its decisions free from government or other parties’ interference. In principal, credibility can hardly achieve because of time inconsistency problems (the prediction of future, which creates a conflict of interest between inflation, unemployment and economic growth) and political interference in the absence of independence.
Over the past 18 months, Bank Indonesia has successfully dealt with time inconsistency. But, it has suddenly encountered a dilemma either pushing the domestic expected inflation low, which is the primary interest of the market speculators, or assisting the government target to achieve 6.4 percent economic growth this year.
Put simply, according to the Philips curve, the higher the unemployment in an economy, the lower the rate of inflation and vice versa, so there would essentially be a trade-off between inflation and unemployment. In this regard, Bank Indonesia seems more interested in the idea to suppress inflation. One point should be questioned, was the recent inflation caused by a monetary phenomenon?
Milton Friedman (1953) believed that sustained inflation is always and everywhere a monetary phenomenon. Accordingly, monetarists tend to emphasize the importance of monetary policy and the view that inflation is essentially a domestic phenomena stemming from continuing increase in the money supply. In this theoretical framework, it can be hypothesized that inflation varies positively with the rate of change in money supply, and negatively with the rate of change in real income.
But, the fact that recent inflation stemmed from negative supply shocks such as a rise in oil prices, bad weather that intrudes the production of staple food, or even the worldwide shortages of grain rethought the idea of solving the inflation without non-monetary policies, which constitutes the authority of the government.
Thus, the provision of a fiscal room for subsidizing capital goods and raw materials that can enhance the sustainability of the food production and the search of new oil-well is very essential.
As Indonesia currently has the biggest interest rate in the Asian region, there will be net capital inflow coming. However, the government should not control this, as our economy lies in a strong position with good trade balance.
My concern right now is that the decision of Bank Indonesia to raise the interest rate would only benefit the speculators who can “frizzle” their investment in financial markets by unexpectedly shifting one financial instrument to another. In the past, Bank Indonesia ran open market operations, just to maintain the exchange rate as well as onset interest rate, and hence at the expense of the state budget.
A relatively stable price level is the principal goal of monetary policy, so it is extremely important that the central bank uses unconventional monetary policy measures to stimulate the economy in the
absence of an interest rate channel in order to restore consumer and business confidence.
Yet, without coordination from the fiscal sector, the rate of inflation cannot be halted.
The writer, an alumnus in a Masters of Applied Economics at The University of Adelaide, Australia, is a lecturer at National University (UNAS), Jakarta and economic policy researcher at Transparency International Indonesia. The opinions expressed are his own.
