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A closer look at Indonesia's business cycle
All in all, it is quite obvious that Indonesia is facing a “financial cycle drag” — like problem.
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New faces in the wallet: Bank Indonesia Governor Agus Martowardojo shows off new rupiah banknotes after their launch. (Antara/Yudhi Mahatma)
I
n macroeconomic textbooks, in the business cycle hypothesis, the expansionpeak phase swiftly emerges after the recession-trough phase. Using this framework, we can consider the year 2015 as the bottom of Indonesia’s economic cycle. Ever since that year, the economy has been growing at around 5 percent again. In the first quarter this year, the economy expanded by 5.01 percent year-on-year.
That said, some issues are still causing concern. First, the business cycle is still over-reliant on the cycle of global commodity prices.
This over-dependency problem, the so-called Dutch Disease, has caused a deep monetary policy trilemma where Bank Indonesia (BI) to some degree has lost its policy sovereignty for the sake of free capital flows and a stable rupiah.
The consequence of prioritizing these two rather than the commodity dependency issue is a non-optimum level of interest rates, which accompanies economic growth, also at a non-optimum pace. It can be seen that Indonesia’s economy is unlikely to peak at the same level again after every crisis recurs.
Many recent studies have discussed the importance of structural reform through infrastructure investment and industrialization to relax the constraints in reaching its optimum potential. Yet, only a few focus on the financial sector development to ensure that optimum allocations of funds occur.
According to Levine in 1997, the financial sector has significant roles in intermediating and accumulating capital. An efficient financial sector tends to prolong the period of expansion and shorten the period of recession.
For the most recent study this year, Borio used the “financial cycle drag ” hypothesis to blame weak financial development as the source of economic predicaments.
