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

Author

Listed:
  • Enrico Tanuwidjaja

    (SCAPE)

  • Choy Keen Meng

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.

Suggested Citation

  • Enrico Tanuwidjaja & Choy Keen Meng, 2005. "Central Bank Credibility and Monetary Policy : Evidence from Small Scale Macroeconomic Model of Indonesia," Macroeconomics Working Papers 22576, East Asian Bureau of Economic Research.
  • Handle: RePEc:eab:macroe:22576
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    References listed on IDEAS

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    1. Svensson, Lars E. O., 2000. "Open-economy inflation targeting," Journal of International Economics, Elsevier, pages 155-183.
    2. 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, pages 356-375.
    3. Leitemo, Kai & Soderstrom, Ulf, 2005. "Simple monetary policy rules and exchange rate uncertainty," Journal of International Money and Finance, Elsevier, pages 481-507.
    4. Laurence M. Ball, 1999. "Policy Rules for Open Economies," NBER Chapters,in: Monetary Policy Rules, pages 127-156 National Bureau of Economic Research, Inc.
    5. John M. de Figueiredo & Brian S. Silverman, 2002. "Academic Earmarks and the Returns to Lobbying," NBER Working Papers 9064, National Bureau of Economic Research, Inc.
    6. 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.
    7. repec:nsr:niesrd:85 is not listed on IDEAS
    8. Svensson, Lars E. O., 2000. "Open-economy inflation targeting," Journal of International Economics, Elsevier, pages 155-183.
    9. Gulasekaran Rajaguru & Reza Siregar, 2002. "Sources of Variations Between The Inflation Rates of Korea, Thailand and Indonesia During The Post-1997 Crisis," Centre for International Economic Studies Working Papers 2002-29, University of Adelaide, Centre for International Economic Studies.
    10. 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, pages 867-884.
    11. Wallis, Kenneth F, 1989. "Macroeconomic Forecasting: A Survey," Economic Journal, Royal Economic Society, vol. 99(394), pages 28-61, March.
    12. 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.
    13. 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.
    14. 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, pages 1-90.
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    17. 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..
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    More about this item

    Keywords

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

    JEL classification:

    • C15 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Statistical Simulation Methods: General
    • C51 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Construction and Estimation
    • E17 - Macroeconomics and Monetary Economics - - General Aggregative Models - - - Forecasting and Simulation: Models and Applications
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • O53 - Economic Development, Innovation, Technological Change, and Growth - - Economywide Country Studies - - - Asia including Middle East

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