Abstract
The tendency of repeating history has made any financial crisis a valuable source to be explored and studied. It will make people be more prepared and ready to anticipate. This paper examined the nature of linkages between exchange rate and macroeconomic fundamentals over 1997-2004. It investigated the evidence on both the short- and long-run effects of exchange rate determinant factors using co-integration theory. It also explored the stability of rupiah during the pre and post economic crisis, seeking whether the Indonesian currency was overshooting or not. To test the stability of rupiah after monetary and fiscal liberalization, we employed the Chow test. The results revealed that the rupiah was overshooting during the crisis' period and there was a structural change of rupiah after 1998. Due to the significant effects of interest rate and exchange rate on the currency stability, it is important to the Indonesia’s monetary institution to be aware of these two variables, especially in stabilizing the economic performance after the financial liberalization. The elasticity obtained for relative money supply (m) is greater than unity indicating that this result consistent with overshooting hypothesis.
Highlights
Indonesia's economic reforms began in the mid 1980s, when government made a monetary and fiscal deregulation in 1983
This paper examines the nature of linkages between exchange rate and macroeconomic fundamentals
We test the stationarity of each time series in order to estimate the co-integrating relationship in the long run and short run
Summary
Indonesia's economic reforms began in the mid 1980s, when government made a monetary and fiscal deregulation in 1983. Reforms were expected at opening the real economy by promoting direct investment flows and liberalizing the financial sector, increasing competition, and promoting growth. The government aimed to support these reforms with improved macroeconomic management, including through an attempt to maintain a competitive and stable exchange rate. The rupiah was linked to a basket of currencies consisting of Indonesia’s main trading partners. The crude petroleum and natural gas dominated the Indonesia’s export trade until the mid 1980s. The oil price largely influenced and determined the government‘s earnings. The collapse of oil price in 1986 led to a devaluation, and government was pushed to boost nonoil/gas exports
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