MONETARY POLICY INERTIA: CASE OF INDONESIA

Ali Nur Ahmad, Ergo Nurpatria Kurniawan

Abstract


Purpose – This paper examine the inertia of monetary policy in the Indonesian economy, in which the monetary policy is neutral owing to the adoption of a managed floating and fixed exchange rate withthe US dollar. The question of the current paper is: Does monetary policy inertia exist in such aneconomy despite the fact that the exchange rate is managed floated and fixed to a foreign currency? Design/methodology/approach – To test the hypothesis of the current paper in Indonesia, the Taylorrule, adjusted to be consistent with the context of monetary policy in Indonesia, is estimated. Moreover,the model is estimated by two techniques: OLS and the Kalman filter, using quarterly data over theperiod (2008:1- 2014:1). Findings – The empirical evidence from the Indonesian economy shows that monetary policy inertiais highly significant in Indonesia. The coefficient of the lagged interest rate is estimated to lie between0.60 and 0.69. Moreover, the evidence illustrates that both inflation rate and output gap have a significant effect on setting the policy rate. Moreover, the policy interest rate seems to be set graduallyin reaction to monetary policy inertia, unobserved variable and foreign interest rate. Originality/value – The paper investigates monetary policy inertia in a developing country whoseeconomy is small, widely opensor managed floating and has a fixed exchange rate with the US dollar.

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