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Central Bank Credibility and Monetary Policy : Evidence from Small Scale Macroeconomic Model of Indonesia

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  • Enrico Tanuwidjaja

    (SCAPE)

  • Choy Keen Meng
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    Abstract

    In this paper, we develop a forward-looking small scale macroeconomic model (SSMM) of the Indonesian economy which is potentially useful for carrying out monetary policy analysis. The Batini-Haldane (1999) model is used as the theoretical underpinning for the development of the model along with the well-known Taylor policy rule (1993). The tracking performance of the model is found to be satisfactory. We conduct deterministic and stochastic simulations to examine the role of the central banks credibility in achieving the inflation target and to suggest appropriate monetary policy responses. Policy simulations indicate that it is crucial for the Indonesian authority to address its credibility for Indonesia to achieve a lower inflation rate. Simulations to trace out the inflation-output tradeoff frontier also show that a monetary policy rule that targeted both the inflation and output gap will result in less macroeconomic volatility. We also found that the inclusion of the exchange rate into the monetary policy rule as an additional feedback variable warrants serious consideration in the future course of monetary policy management.

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    Bibliographic Info

    Paper provided by East Asian Bureau of Economic Research in its series Macroeconomics Working Papers with number 22576.

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    Date of creation: Jan 2005
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    Handle: RePEc:eab:macroe:22576

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    Related research

    Keywords: Small Scale Macroeconomic Model; monetary policy; Central Bank Credibility; Policy Frontier;

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    References

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    1. Siregar, Reza & Rajaguru, Gulasekaran, 2005. "Sources of variations between the inflation rates of Korea, Thailand and Indonesia during the post-1997 crisis," Journal of Policy Modeling, Elsevier, vol. 27(7), pages 867-884, October.
    2. Nickerson, Jack A., 1999. "Learning by Doing in Markets, Firms, and Countries. Edited by Naomi R. Lamoreaux, Daniel M. G. Raff, and Peter Temin. A National Bureau of Economic Research conference report. Chicago: University of C," The Journal of Economic History, Cambridge University Press, vol. 59(03), pages 854-855, September.
    3. Hill,Hal, 2000. "The Indonesian Economy," Cambridge Books, Cambridge University Press, number 9780521663670, November.
    4. Blake, Andrew P & Westaway, Peter F, 1996. "Credibility and the Effectiveness of Inflation Targeting Regimes," The Manchester School of Economic & Social Studies, University of Manchester, vol. 64(0), pages 28-50, Suppl..
    5. Tilak Abeysinghe & Kristin Forbes, 2005. "Trade Linkages and Output-Multiplier Effects: a Structural VAR Approach with a Focus on Asia," Review of International Economics, Wiley Blackwell, vol. 13(2), pages 356-375, 05.
    6. Pierre-Yves HENIN & Marie PODEVIN, 2002. "Assessing the Effects of Policy Changes: Lesson from the European 1992 Experience," Annales d'Economie et de Statistique, ENSAE, issue 67-68, pages 435-461.
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