Monetary conditions in Indonesia: A pre- and post-IT analysis

Abstract

Monetary Conditions Index (MCI) is a measure of monetary policy stance either tight, neutral or loose relative to the targeted objective. The MCI is designed specifically for small open economies as both exchange rates and interest rates are influential in describing the economic behaviour of a country. In this study, we exclusively focusing on Indonesia as it was severely attacked by financial crisis (1997-2000) that spin out with worst recession than any other neighboring regions. Eventually, causing a drastic shift in the exchange rate regime from a fixed to a floating exchange rate system as well as a transformation in the monetary policy regime from a money targeting to an inflation targeting (IT) policy framework. Hence, we use two variant time series data consists of the pre-IT (1980Q1-1996Q4) and post-IT (2002Q1-2015Q4) periods by incorporating the autoregressive distributed lag (ARDL) model estimation and bounds testing procedure to construct the weights of MCIs. The results reveal that the exchange rate channel is more robust than the interest rate channel in the transmission mechanisms of both policy regimes. However, the interest rate channel is much weightier in the post-IT than the pre-IT. Besides that, the plotted MCIs characterizing almost a tighter stance in the pre-IT whilst looser stance in the post-IT. Overall, the movements in the MCIs are feasible enough to illuminate the behaviour of policy-making which is somehow parallel to the economic condition in Indonesia.