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Fiscal Constraints in the Financial System Stability Framework for Indonesian Data

Author

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  • Kindy R. Sjahrir

    (Fiscal Policy Office, Ministry of Finance. Republic of Indonesia)

Abstract

A number of macroeconomic episodes such as the 2018 global financial crisis, the tantrum taper for 2013-2015 show that financial system stability is closely related to the real economic sector, monetary policy and public finance. The analysis of dynamic general equilibrium as a microeconomic characteristic of New Keynesian macroeconomics makes real cohesion of fiscal, monetary, financial and business cycles complex, ambiguous and complex due to the many factors that work in different directions. Literature studies show that until now there has been no consensus among mainstream economists about the criteria or standard definition of fiscal sustainability within the framework of financial system stability. This study aims to fill the gap for Indonesian quarterly data from 2005 to 2017. The research premise that fiscal sustainability is an important factor in financial stability, for Indonesian data, especially through the transmission of fiscal imbalances and the government debt crisis. The reverse effect of the shock of monetary imbalance on the fiscal crisis is the second research question in this study. The literature suggests that the growing interdependence between fiscal policy and the financial sector leads to strengthening the two-way relationship between fiscal sustainability and financial stability. Fiscal constraints in relation to financial system stability for Indonesian data are reformulated as applied economic analysis to explain (1) indicators of fiscal sustainability in Indonesia; (2) secure intertemporal dynamic limits on debt for fiscal solvency; and (3) explain fiscal transmission to the financial system and the opposite of solvent fiscal financing operations. For emerging market countries such as Indonesia, with financial markets still developing without the complications of derivative financial markets and expanding bonds between the central and regional governments - presumably inter temporal budgetary constraints can be an indication of the main criteria for fiscal sustainability. Adopting the concept of Bagnai, Alberto (2004) and Burnside, Craig (2005) conception of the transmission of fiscal sustainability and the financial system - including monetary in this study stems from the definition of twin deficits in the national accounts. Analysis of fiscal sustainability from debt solvency and its relationship vis-à-vis with the financial system is carried out through structural vector autoregression analysis of the dynamics of three research questions for endogenous public debt to the fiscal stance and primary fiscal balance. The main references to this approach are Favero and Giavazzi (2007, 2009) to analyze the effect of primary equilibrium on GDP growth using the narrative of Romer and Romer (2010) and the structure of Blanchard and Perotti (2002). Empirical studies on this working paper show that (1) the shock of fiscal risk to the financial system for Indonesia's data now is mutually reinforcing (empirical studies on this working paper show that fiscal risk from financial system risk with current Indonesian data is not mutually reinforcing), and (2) shock from the financial system does not have a permanent impact on the primary balance and debt-to-gdp ratio. Significant contagion potential from two-way feedback on fiscal risk and financial system risk with current Indonesian data, shock from primary balance and debt-to-gdp ratio have a permanent impact on loan interest rates, and the temporary impact on inflation and GDP growth. The results of the empirical analysis of the SVAR model of this study indicate that it is important to be able to conduct good supervision and governance over the development of primary balance and periodic debt-to-GDP ratio for financial system stability. Both indicators provide a portrait of fiscal balance for a certain period. While the transmission of fiscal sustainability to the real business, financial and monetary cycles can be observed from indicators of liquidity, solvency and fiscal sustainability. The effect of primary balance and debt-to-GDP ratio is derived from the identity of the flow of funds with a two-way feedback loop between the financial sector (banking and monetary) and the fiscal stance.

Suggested Citation

  • Kindy R. Sjahrir, 2018. "Fiscal Constraints in the Financial System Stability Framework for Indonesian Data," Working Papers in Economics and Development Studies (WoPEDS) 201803, Department of Economics, Padjadjaran University, revised Dec 2018.
    • Handle: RePEc:unp:wpaper:201803
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    References listed on IDEAS

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    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

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