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

Author

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  • 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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    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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