ARIMBI with Extended External Sector

Indonesia’s economy is getting more integrated with the global economy. Potential impact of global economy shocks to domestic economy propagated through trade channel and financial channel are increasingly pronounced. Risk of sudden reversal following large capital inflows poses a serious threat to Indonesia’s economy. Meanwhile, Indonesia’s own domestic concerns regarding high current account deficit as a result of high growth of imports have yet to abate. To cope with these growing concerns on external sector, Bank Indonesia’s FPAS needs to be equipped with macroeconomic model with a more complete features of external sector. This paper explores modelling of the dynamics of current account and capital flows, and its incorporation into existing ARIMBI + Macroprudential model (a Semi Structural New Keynesian Model). Here we add external block to ARIMBI + Macroprudential model. This extension consists of two equations, i.e. current account gap and capital flows gap. In addition, output gap equation is modified to accomodate current account linkage to GDP. Meanwhile credit growth gap equation is modified to account for impact of BOP surplus/deficit to domestic liquidity. Simulation of the model shows that its impulse response function is in line with theoretical background while the behaviour of main variables is maintained to be similar with ARIMBI + Macroprudential. Through financial accelerator mechanism, procyclicality of real and financial sector is revealed. The simulation shows that policy mix can mitigate unintended impact of business cycle and financial cycle, as well as shocks from external sector. Its forecasting performance is also improved.