Dr. Ross McLeod

Monetary Policy Confusion

It is not easy to know the true stance of monetary policy in Indonesia these days. In September it was announced that system liquidity was to be increased, in line with what was going on in many other countries in response to the emerging global financial crisis. Yet it was also stated that the central bank policy rate was not going to be reduced, notwithstanding the fact that liquidity and interest rates are opposite sides of the same coin.

This attempt to have it both ways reflects the dilemma facing Bank Indonesia. On the one hand, it is required by law to safeguard the value of the rupiah: that is, to minimise both inflation and depreciation of the currency. On the other, it also feels obliged to take other macroeconomic considerations into account. It is virtually certain that the global economic slowdown will have a negative impact on Indonesia’s growth. With this in mind, it is very difficult to tighten monetary policy in response to inflation now being twice the targeted level.

But it would appear that BI well remembers its experience during the last crisis, in 1998, at which time its highly expansionary monetary policy caused a sudden burst of very high inflation–far higher than in the other Asian crisis countries–while at the same time the growth of output turned sharply negative. On the basis of this experience, it seems that tight monetary policy can be relied on to reduce inflation, but monetary expansion cannot be guaranteed to provide a growth stimulus.

Presumably for this reason, Bank Indonesia chose to stand out from the crowd of other central banks by pushing interest rates up in the second half of this year and then holding them steady when all the others were implementing drastic cuts. Now, it seems, the discomfort of maintaining a monetary policy quite different from its peers has become too much. BI announced a modest 25 basis point reduction in its policy rate last week.

But all is not what it seems. To understand what monetary policy is, as distinct from what the authorities say it is, it is necessary to focus on the data. Two things stand out.

First, liquidity had been rising very rapidly for several months (at about 30% per annum), notwithstanding the increase in the policy rate from 8% in April to 9.5% in October. In other words, the apparent tightening in policy still left that policy highly expansionary. Liquidity growth did indeed slow in October, but only to about 20%, which is in fact still highly expansionary.

Second, the so-called “policy rate” has become almost entirely meaningless as an indication of the stance of policy. For several years the key indicator rate was that on one month certificates of the central bank (SBIs), and the term “policy rate” was not used officially. When the authorities began to use this new terminology in July 2005 it still reflected the one month SBI rate. But in about May this year a gap began to emerge between the nominal policy rate and the one-month SBI rate (Chart). By the end of October the policy rate was 9.5%, whereas the SBI rate was about 11.25%. In an environment where there policy rate adjustments have typically been just 25 basis points, this is a huge difference. The policy rate no longer refers to any interest rate in the market. It is a rate that exists only in the minds of the authorities and in their public statements. It is the market rate on BI’s key instrument of monetary policy–the one-month SBI–that sets the benchmark for market conditions.

Will the reduction of the policy rate to 9.25% affect market rates? The SBI rate in the most recent auction did fall by 25 basis points as well, to 11%. It will be interesting to see if the gap between the two rates remains at this level. If it does, issuance of SBIs is likely to decline, and liquidity growth will accelerate once again. On the other hand, if the gap becomes even wider, the so-called “policy rate” will become even less relevant as an indication of the true stance of monetary policy.


* Dr. Ross McLeod has been working in and on Indonesia in various capacities — postgraduate student, consultant and academic researcher — since 1978, and speaks Indonesian fluently. Since 1998 he has been the Editor of the Bulletin of Indonesian Economic Studies. This analysis was originally published on ANU Indonesia Project blog, to which Dr. McLeod regularly contributes to.

Prabowo Ingin Bentuk 'Executive Heavy" dengan Rangkul Semua Parpol, Kata Peneliti BRIN
Reskrim Polres Metro Jakarta Barat meringkus sipir taksi online bernama Michael Gomgom (30), yang menodong dan memeras seorang wanita yang menjadi penumpangnya.

Sopir Taksi Online yang Todong Penumpang Wanita dan Minta Rp 100 Juta Ditangkap saat Tidur Pulas

Reskrim Polres Jakarta Barat, meringkus sopir taksi online, Michael Gomgom (30), yang menodong dan memeras seorang wanita yang menjadi penumpangnya. Dia sedang istirahat.

img_title
VIVA.co.id
29 Maret 2024