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Expectations and the inertia of inflation: The case of Indonesia

Author

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  • Wimanda, Rizki E.
  • Turner, Paul M.
  • Hall, Maximilian J.B.

Abstract

It has long been recognised that the balance between backward-looking and forward-looking expectations has critical policy implications. This is because backward-looking expectations impart a substantial degree of inertia to the inflation rate whereas forward-looking expectations lead to rapid adjustment in response to shocks. In this paper we examine the policy implications for the Indonesian economy of the form taken by the price adjustment equation. We allow for both backward-looking and forward-looking effects of inflation expectations, proxying forward expectations with the realised rate and using a GMM estimator to allow for the resulting endogeneity. Using monthly data from 1980:1 to 2008:12, our estimates show that CPI inflation in Indonesia is significantly determined by backward-looking inflation expectations, forward-looking inflation expectations, the output gap, exchange rate depreciation, and money growth. However, the backward expectation attracts a significantly higher weight than the forward rate leading to the conclusion that inflation in Indonesia has considerable inertia. The implication of this is that a gradualist monetary policy is likely to be more effective as a means of smoothing fluctuations in inflation and real output.

Suggested Citation

  • Wimanda, Rizki E. & Turner, Paul M. & Hall, Maximilian J.B., 2011. "Expectations and the inertia of inflation: The case of Indonesia," Journal of Policy Modeling, Elsevier, vol. 33(3), pages 426-438, May.
  • Handle: RePEc:eee:jpolmo:v:33:y:2011:i:3:p:426-438
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    References listed on IDEAS

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    Cited by:

    1. Stockhammar, Pär & Österholm, Pär, 2016. "Do Inflation Expectations Granger Cause Inflation?," Working Papers 2016:4, Örebro University, School of Business.
    2. repec:spr:decisn:v:45:y:2018:i:1:d:10.1007_s40622-018-0179-7 is not listed on IDEAS
    3. Sensarma, Rudra & Bhattacharyya, Indranil, 2016. "The impact of monetary policy on corporate bonds in India," Journal of Policy Modeling, Elsevier, vol. 38(3), pages 587-602.
    4. Djuranovik, Leslie, 2014. "The Indonesian macroeconomy and the yield curve: A dynamic latent factor approach," Journal of Asian Economics, Elsevier, vol. 34(C), pages 1-15.
    5. Rizki E. Wimanda, 2014. "Threshold effects of exchange rate depreciation and money growth on inflation: Evidence from Indonesia," Journal of Economic Studies, Emerald Group Publishing, vol. 41(2), pages 196 - 215, March.
    6. Kadria, Mohamed & Ben Aissa, Mohamed Safouane, 2016. "Inflation targeting and public deficit in emerging countries: A time varying treatment effect approach," Economic Modelling, Elsevier, vol. 52(PA), pages 108-114.
    7. Abo-Zaid, Salem & Tuzemen, Didem, 2012. "Inflation Targeting: A three-decade perspective," Journal of Policy Modeling, Elsevier, vol. 34(5), pages 621-645.
    8. Palma, Andreza Aparecida & Portugal, Marcelo Savino, 2014. "Preferences of the Central Bank of Brazil under the inflation targeting regime: Estimation using a DSGE model for a small open economy," Journal of Policy Modeling, Elsevier, vol. 36(5), pages 824-839.

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