Measuring the Time Inconsistency of Monetary Policy in Indonesia

Abstract

This study measured the time inconsistency of monetary policy in Indonesia using the asymmetric preference parameter in linear exponential loss function of the central bank. Asymmetric central bank preference becomes an important issue since many of the results on the time inconsistency problem under symmetric preferences may no longer hold under asymmetric preferences. Using two sub-samples, i.e. before and after the implementation of central bank independence act, the conditional mean and the conditional variance of the output gap were estimated and then proceed to estimate the reduced form of the model. The results showed the existence of an asymmetric preference parameter before the Bank Indonesia independence act, which indicated the presence of a time inconsistency problem of monetary policy. This finding implies Bank Indonesia put a negative weight instead of positive weight on the output gap prior to its independency. However, after the implementation of central bank independence, the monetary policy of Bank Indonesia has been consistent with symmetric policy preference over price stability and output. Keywords: Time inconsistency, discretionary, monetary policy, asymmetric central bank preference, output gap, inflation bias.JEL Classification : E52, E58