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

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  • Enrico Tanuwidjaja

    ()
    (Singapore Centre for Applied and Policy Economics, Department of Economics, National University of Singapore)

  • Choy Keen Meng

    (Division of Economics, School of Humanities and Social Sciences, Nanyang Technological University, Singapore)

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 bank’s 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 National University of Singapore, Department of Economics, SCAPE in its series SCAPE Policy Research Working Paper Series with number 0514.

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Date of creation: Nov 2005
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Handle: RePEc:sca:scaewp:0514

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Web page: http://www.fas.nus.edu.sg/ecs/scape/index.html
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Related research

Keywords: Small Scale Macroeconomic Model; Monetary Policy; Central Bank Credibility; Policy Frontier; Indonesia;

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  1. Svensson, Lars E O, 1998. "Open-Economy Inflation Targeting," CEPR Discussion Papers 1989, C.E.P.R. Discussion Papers.
  2. Batini, Nicoletta & Nelson, Edward, 2001. "The Lag from Monetary Policy Actions to Inflation: Friedman Revisited," International Finance, Wiley Blackwell, vol. 4(3), pages 381-400, Winter.
  3. Nicoletta Batini & Andrew Haldane, 1999. "Forward-Looking Rules for Monetary Policy," NBER Chapters, in: Monetary Policy Rules, pages 157-202 National Bureau of Economic Research, Inc.
  4. Steven Radelet & Jeffrey D. Sachs, 1998. "The East Asian Financial Crisis: Diagnosis, Remedies, Prospects," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 29(1), pages 1-90.
  5. Hill,Hal, 2000. "The Indonesian Economy," Cambridge Books, Cambridge University Press, number 9780521663670, November.
  6. Tilak Abeysinghe & Kristin J. Forbes, 2001. "Trade Linkages and Output-Multiplier Effects: A Structural VAR Approach with a Focus on Asia," NBER Working Papers 8600, National Bureau of Economic Research, Inc.
  7. Leitemo, Kai & Söderström, Ulf, 2001. "Simple Monetary Policy Rules and Exchange Rate Uncertainty," Working Paper Series 122, Sveriges Riksbank (Central Bank of Sweden).
  8. Forbes, Kristin J. & Abeysinghe, Tilak, 2002. "Trade Linkages and Output-Multiplier Effects: A Structural VAR," Working papers 4242-01, Massachusetts Institute of Technology (MIT), Sloan School of Management.
  9. Andrew P. Blake and Peter F. Westaway, . "Credibility and the effectiveness of inflation targeting regimes," NIESR Discussion Papers 85, National Institute of Economic and Social Research.
  10. Taylor, John B, 2000. "Alternative Views of the Monetary Transmission Mechanism: What Difference Do They Make for Monetary Policy?," Oxford Review of Economic Policy, Oxford University Press, vol. 16(4), pages 60-73, Winter.
  11. Wallis, Kenneth F, 1989. "Macroeconomic Forecasting: A Survey," Economic Journal, Royal Economic Society, vol. 99(394), pages 28-61, March.
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