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Insight: The receding threat of inflation
Is inflation no longer a threat in Indonesia? The record of the last three years would suggest this is so. But is this temporary or permanent?
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Old lady is sleeping around her products at Giwangan Market, Yogyakarta, Indonesia. The non-core part of inflation changes when food and energy prices move. (Shutterstock.com/Bambang Wijaya)
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s inflation no longer a threat in Indonesia? The record of the last three years would suggest this is so. But is this temporary or permanent? To answer this we need to study the underlying factors that drive inflation, and then use them to guess what the future holds.
Inflation in Indonesia averaged 10 percent in the period 1975-1997. It rose to around 29 percent during the Asian Financial Crisis of 1997-2000. And fell back to around 7.5 percent afterward in 2000-2014. Between 2015 and 2017 the average rate declined again to 4.6 percent. Besides the rate declining, its volatility also eased.
Why so substantial a decline in inflation?
The explanation lies in how the components of inflation move about. One way to break down inflation is by its core and non-core components. Core inflation represents how supply interacts with demand, and persists over time. Called the demand side of inflation, it also responds to monetary policy. If interest rates go up, consumers tend to save rather than spend. Lower spending means demand goes down and so does inflation.
The non-core part of inflation changes when food and energy prices move. It is also subject to changes in government policy, such as fuel subsidies. These influences can move inflation in an instant but are usually transitory. Non-core inflation is also referred to as the supply side of inflation.
Core inflation is usually lower than headline inflation. For example during 2015-2017, core inflation was stable at 3.8 percent versus headline inflation of 4.6 percent. In 2017 alone, core inflation was 3 percent, food inflation was 0.71 percent but administered prices rose by 8.7 percent.
This confirms the hypothesis that in the longer run core inflation forms the trend. Meanwhile, non-core factors result in actual inflation moving around the trend.
