Abstract
Bank Indonesia set inflation targeting framework from 1 July 2005 by publicizing the inflation target or forward inflation to the public. However, the phenomenon show that most of the actual inflation of Indonesia is not in accordance with inflation targeting that have been set by Bank Indonesia. The purpose of this research is to analyze and know the flow of monetary policy transmission mechanism of expectation line in influencing inflation, to analyze and to know the influence of long-term and short-term and the shocks of interest rate, exchange rate, inflation expectations, output gap and GDP on inflation in Indonesia. The variables used in this research are BI Rate, Exchange Rate, Inflation Expectation, Output Gap, GDP and Inflation. The data used in this research is monthly data of time series from January 2006 until June 2016 which come from Bank Indonesia (BI) and Central Statistic Agency (BPS). The method used in this research is Vector Error Correction Model (VECM). The result of research indicates that: The flow of monetary policy transmission mechanism of expectation line in influencing inflation in Indonesia runs continuously with indicated the existence of two-way relationship between exchange rate and inflation variable, in the short term, the BI Rate, Exchange Rate and Output Gap are significant and positively affect inflation, inflation expectation variables are significant and affect inflation and GDP variable is insignificant to inflation in Indonesia, while in long run variable affecting inflation rate are BI Rate and inflation expectations, based on the variance decomposits result shows that the biggest variant contributing to inflation in Indonesia is the BI Rate.
Highlights
Bank Indonesia sets the interest rate as one of the monetary policy instruments to influence the exchange rate which will affect the price level (Kadir, Priyo and Guruh 2008)
Vector Error Correction Model (VECM) is a form of VAR that these restricted VAR was first introduced by Sims in 1980 as alaternatif models developed from models Auto Distributed Lag (ADL) with the consideration of minimizing the theoretical approach with the purpose of being able to explain economic phenomena as well (Widarjono, 2009), in VECM analysis consists of 8 stages, namely, Stationarity Test, Test Optimization Lag, Cointegration Test, Stability Test, Granger Causality Test, VECM, Impulse Response Function (IRF) and Variance Decomposite (VD)
Changes in exchange rates are responded by inflation expectations, which changes in inflation expectations by communities impact on changes in output demand
Summary
Bank Indonesia sets the interest rate as one of the monetary policy instruments to influence the exchange rate which will affect the price level (Kadir, Priyo and Guruh 2008). In Indonesia there are several types of monetary policy transmission mechanism mechanisms such as interest rate, exchange rate, asset price line, credit line and expectation line (Warjiyo, 2004). One important path in the monetary policy transmission mechanism is to achieve the ultimate goal is the mechanism of transmission of monetary policy path of expectations. This is due to the factors of uncertainty and trends in both the monetary sector as well as in the real sector. An expansionary monetary policy decreases the real interest rate and leads to a reduction in the real interest rate which boosts the investment and increase the product (Mgadmi, 2015)
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