Abstract
This paper analyzes the effects of fiscal and monetary policies on inflation rate in Indonesia. This research uses the error correction model for estimating the empirical model of inflation rate for annual data 1970-2017. The results present the significant effects of fiscal and monetary variables on the inflation rate. These findings reveal the inflationary effects of fiscal and monetary policies in the country. This research also finds the impact of output and exchange rate on inflation rate. Therefore, this paper supports the theory of demand-pull inflation as well as the proposition of imported inflation. The other uniqueness of this research is the inclusion of shock variables in the empirical model. This study asserts the significant role of inflation shock and unanticipated exchange rate on the domestic price level. It implies that domestic inflation is closely related to the international financial sector.
Highlights
Since its independence in 1945, Indonesia has experienced some phases of price instability
This research provides some empirical model of inflation rate based on the dynamic econometric analysis
The alternative error correction model which we develop in this research can explain the determinants of inflation rate in Indonesia for the long period data
Summary
Since its independence in 1945, Indonesia has experienced some phases of price instability. The hyperinflation occurred in 1950-1960s causing a serious political and economic crisis. This phenomenon was suspected as a consequence of the emerge of political instability and as an impact of the failure of fiscal and monetary policy (Hossain, 2005). In the early of five years periodical development plan in 1970, Indonesia was remarkable as a successful country in stabilizing the economy. The central government has successfully controlled the price change for about five decades except in the financial crises in 1998 which caused inflation rate about 60 percent this year. Starting in the 2000s, the average of inflation rate is less than 10 percent per annum for one decade. This inflation rate is more than target which is around 7-8 percent per annum
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