On 5 January 2010, Bank Indonesia decided to keep its main interest rate reference (the BI rate) at 6.5% because inflationary threats are deemed to come from supply fronts as reflected by surges of (volatile) commodity and food prices. BI believes and hopes (see the last paragraph of its published statement) that the government will address the supply side issues (e.g. production capacity and distribution system) to combat rising prices.
This line of reasoning needs to be checked once and again since BI might be overrating supply side issues and the importance to further enhance policy coordination with government in addressing them. I believe, in the long run, inflationary effects of supply shocks depend on propagation through expectations and inflationary inertia. If implemention of its inflation targeting is credible, this propagation can be limited. Getting involved too far in addressing supply side issues could weaken BI's focus and accountability.
BI should also retain its independence. In my view, holding up the economy via easy monetary policy now is not opportune and could discourage productive investment in sectors where productivity gains are high (industry, education, innovation) in favor of activities linked to credit (real estate, finance).
BI should employ instruments to tackle inflationary pressures at an early stage and guide inflation expectations. It also needs to look at its macroprudential tools chest to prevent (future) asset bubbles, which are currently indicated by surging real estate and stock prices. Raising rates rapidly later to contain inflation in a "leaning against the wind" mode can be detrimental to output and financial stability. To prevent expectations of higher inflation and bigger problems in the future, BI should send strong signal to investors. See for those interested, a review discussion on the timing of monetary policy measures here. Or a cautious view of monetary policy possibilities to prick bubbles here
The fact that the GDP growth rate is 'only 6%' in 2010 does not mean BI has a room to further boost economic growth by essentially over-encouraging banks to expand credits.
Though Indonesia's credit-to-GDP ratio is lower than neighbouring countries, it is the rise of the ratio above the trend (read: too high loan growth) that precipitates the most serious episodes of banking sector problems in the world. That is why the Basel Committee recommends using the trend in credit-to-GDP ratio as a major determinant of required countercyclical capital buffer in the future (under the Basel 3 Accord).
Given its institutional constraints, underdeveloped infrastructure and other supply related challenges, 6% maybe the natural rate of GDP growth for Indonesia at the present moment. Stimulating demand to achieve growth above that rate would only be inflationary and lead to external imbalances.
The central bank of Indonesia needs to focus on its principal objectives to maintain price stability and the stability of the banking sector. Trying too hard to alleviate long-term constraints with purportedly 'pro-growth' policies means planting the seeds of future financial crashes.
By pursuing a more credible inflation targeting, BI will give incentives to the government to focus more on its investment in infrastructure and institutional capabilities, shore up the fight against corruptions and facilitate technological innovations. For in the long run, all of that are positive for productivity growth (hence the supply side!) and will likely be associated with lower inflation (see e.g Mt. Kiley, 2003)
This line of reasoning needs to be checked once and again since BI might be overrating supply side issues and the importance to further enhance policy coordination with government in addressing them. I believe, in the long run, inflationary effects of supply shocks depend on propagation through expectations and inflationary inertia. If implemention of its inflation targeting is credible, this propagation can be limited. Getting involved too far in addressing supply side issues could weaken BI's focus and accountability.
BI should also retain its independence. In my view, holding up the economy via easy monetary policy now is not opportune and could discourage productive investment in sectors where productivity gains are high (industry, education, innovation) in favor of activities linked to credit (real estate, finance).
BI should employ instruments to tackle inflationary pressures at an early stage and guide inflation expectations. It also needs to look at its macroprudential tools chest to prevent (future) asset bubbles, which are currently indicated by surging real estate and stock prices. Raising rates rapidly later to contain inflation in a "leaning against the wind" mode can be detrimental to output and financial stability. To prevent expectations of higher inflation and bigger problems in the future, BI should send strong signal to investors. See for those interested, a review discussion on the timing of monetary policy measures here. Or a cautious view of monetary policy possibilities to prick bubbles here
The fact that the GDP growth rate is 'only 6%' in 2010 does not mean BI has a room to further boost economic growth by essentially over-encouraging banks to expand credits.
Though Indonesia's credit-to-GDP ratio is lower than neighbouring countries, it is the rise of the ratio above the trend (read: too high loan growth) that precipitates the most serious episodes of banking sector problems in the world. That is why the Basel Committee recommends using the trend in credit-to-GDP ratio as a major determinant of required countercyclical capital buffer in the future (under the Basel 3 Accord).
Given its institutional constraints, underdeveloped infrastructure and other supply related challenges, 6% maybe the natural rate of GDP growth for Indonesia at the present moment. Stimulating demand to achieve growth above that rate would only be inflationary and lead to external imbalances.
The central bank of Indonesia needs to focus on its principal objectives to maintain price stability and the stability of the banking sector. Trying too hard to alleviate long-term constraints with purportedly 'pro-growth' policies means planting the seeds of future financial crashes.
By pursuing a more credible inflation targeting, BI will give incentives to the government to focus more on its investment in infrastructure and institutional capabilities, shore up the fight against corruptions and facilitate technological innovations. For in the long run, all of that are positive for productivity growth (hence the supply side!) and will likely be associated with lower inflation (see e.g Mt. Kiley, 2003)
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