Understanding monetary and fiscal policy rule interactions in Indonesia

ABSTRACT

We examine the interaction of monetary and fiscal policies in Indonesia from 1974Q2 to 2019Q1. Within a standard structural vector autoregression framework, we show that the reactions of the policy rules are consistent with theoretical predictions. For instance, a contractionary monetary policy is trailed by a contractionary fiscal policy with lower government expenditure. We extend the analysis to evaluate the interaction of policy rules during active and passive regimes. We show that monetary and fiscal policies are not synchronized over the full sample period, suggesting structural and institutional rigidities, particularly in the past. Restricting the sample to a recent period, we find the policies are more harmonized. We attribute this to the recent joint policy coordination initiatives between the monetary and fiscal authorities.

KEYWORDS:

• Fiscal policy
• monetary policy
• policy interactions
• Indonesia

JEL CLASSIFICATION:

• E61
• E63

Disclosure statement

No potential conflict of interest was reported by the author(s).

Notes

1 See Table A2 in the Appendix for a summary of the recent joint policy coordination initiatives between the monetary and fiscal authorities.

2 See https://oxfordbusinessgroup.com/analysis/accommodative-strategy-new-fiscal-policies-have-boosted-investor-confidence-0 and https://www.bloomberg.com/news/articles/2019-10-24/indonesia-cuts-key-rate-for-fourth-month-in-row-to-spur-economy.

3 See Word Bank available at http://www.worldbank.org/en/news/press-release/2016/05/31/world-bank-approves-first-400-million-fiscal-reform-development-policy-lending-in-indonesia.

4 Based on the Bank Indonesia Law of 1999, BI has a single monetary policy objective of achieving and maintaining stability of the rupiah. Following this law, BI formally adopted the Inflation Targeting Framework (ITF) in July 2005 (for details, see Juhro and Goeltom 2015).

5 See Monetary and Fiscal Policy Coordination, available at https://www.bi.go.id/en/moneter/koordinasi-kebijakan/Contents/Default.aspx.

6 See Cevik, Dibooglu, and Kutan (2014).

7 See Clarida, Galí, and Gertler (1998) and Assenmacher-Wesche (2006) for details.

8 See Prasetyo (2018) for a thorough synthesis of Indonesiaʻs tax reforms.

9 In percentage terms, the output gap is calculated as $\left[\frac{y_t-y_t^{\ast }}{y_t^{\ast }}\right]\times 100$, where $y_t$ is the actual output and $y_t^{\ast }$ is the potential output. The average potential output is 3.520, while the gap is 0.003. Hence, the output gap is 0.09%.

10 See Kliem, Kriwoluzky, and Sarferaz (2016) and Wang (2018) for variant forms of the monetary and fiscal policy interaction VAR framework.

11 This is consistent with prior studies, such as Iyke (2018, 2019b).

12 The stationarity properties of variables for the restricted sample (results are unreported but are available on request) are consistent with those reported for the full sample in Panel A of Table 2.

13 See https://www.reuters.com/article/us-indonesia-president-budget/indonesia-president-proposes-178-billion-budget-for-2020-with-focus-on-education-idUSKCN1V60KI and  https://www.reuters.com/article/us-indonesia-tax/indonesias-corporate-tax-cut-to-cost-up-to-6-billion-tax-chief-idUSKCN1VQ1M2.

14 See the World Bank, available at http://www.worldbank.org/en/news/press-release/2016/05/31/world-bank-approves-first-400-million-fiscal-reform-development-policy-lending-in-indonesia.

15 See https://oxfordbusinessgroup.com/analysis/accommodative-strategy-new-fiscal-policies-have-boosted-investor-confidence-0 and https://www.bloomberg.com/news/articles/2019-10-24/indonesia-cuts-key-rate-for-fourth-month-in-row-to-spur-economy.