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How Indonesia's monetary policy affects key variables

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  • Ahmed, Sadiq
  • Kapur, Basant K.

Abstract

The objective of this paper is to examine the determination of interest rates, inflation and nominal exchange rates in Indonesia, and investigate the role of monetary policy in affecting these variables. In the short term, monetary policy can be used to protect domestic interest rates from the destabilizing influence of speculative capital flight. In the long run, monetary policy can help lower domestic nominal interest rates by maintaining low inflation and dampening expectation about depreciation. The potential for reducing interest rates through monetary expansion is limited. Domestic inflation is partly a monetary phenomenon but structural factors also affect it. The effects of international inflation are immediate and strong; the effects of wage pushes are smaller and less immediate. Inflation can be reduced to some extent by slowing the growth of money - which strengthens the secondary influence of a slower crawling exchange rate. A managed float is appropriate for maintaining a competitive exchange rate, given the gap between world and domestic inflation caused by structural and monetary factors. Real depreciation of the exchange rate will be necessary to compensate for unanticipated decline in oil income (from lower than expected oil prices).

Suggested Citation

  • Ahmed, Sadiq & Kapur, Basant K., 1990. "How Indonesia's monetary policy affects key variables," Policy Research Working Paper Series 349, The World Bank.
    • Handle: RePEc:wbk:wbrwps:349
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    References listed on IDEAS

    as
    1. Carr, Jack & Darby, Michael R., 1981. "The role of money supply shocks in the short-run demand for money," Journal of Monetary Economics, Elsevier, vol. 8(2), pages 183-199.
    2. Friedman, Milton, 1977. "Nobel Lecture: Inflation and Unemployment," Journal of Political Economy, University of Chicago Press, vol. 85(3), pages 451-472, June.
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    Cited by:

    1. Ms. Uma Ramakrishnan & Mr. Athanasios Vamvakidis, 2002. "Forecasting Inflation in Indonesia," IMF Working Papers 2002/111, International Monetary Fund.
    2. -, 1993. "Finance and the real economy: issues and case studies in developing countries," Sede de la CEPAL en Santiago (Estudios e Investigaciones) 30181, Naciones Unidas Comisión Económica para América Latina y el Caribe (CEPAL).
    3. Das Gupta, Dipak & Das Gupta, Bejoy & DEC, 1994. "Interest rates in open economies : real interest rate parity, exchange rates, and country risk in industrial and developing countries," Policy Research Working Paper Series 1283, The World Bank.

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