Research

Monetary and Macroprudential Policy Mix under Financial Frictions Mechanism with DSGE Model

This research presents a Dynamic Stochastic General Equilibrium (DSGE) model tailored for Indonesia's small open economy, augmented by financial frictions manifesting as collateral constraints among households and a financial accelerator affecting entrepreneurs. By incorporating the banking sector into the model, it facilitates an examination of the policies necessary to mitigate shocks arising from the banking sector and their repercussions on financial intermediaries, specifically banks, within the economy.

The model illustrates that shocks within the banking sector, such as an increase in the Capital Adequacy Ratio (CAR) requirement, influence the real sector via the credit channel, consequently undermining the Gross Domestic Product (GDP) and causing a decrease in the inflation rate. The mechanism of the financial accelerator evidenced in the model reveals a procyclical nature of the financial system in relation to economic conditions. Economic contractions prompt a reduction in the amount of credit extended by the banking sector, which represents the primary risk encountered by banks. In situations characterised by an uptick in ex-post idiosyncratic shocks, surpassing ex-ante projections, it becomes evident that the banks' assessments of an entrepreneur's anticipated return on capital outweigh actual outcomes, compelling banks to absorb the associated risks. Such circumstances induce banks to curtail credit allocations to safeguard their capital reserves.

Simulations indicate that a combined approach of monetary and macroprudential policies not only secures sustainable GDP growth and stable inflation but also contributes to the regulation of consumption, thereby decreasing the demand for imported goods. In conjunction with stable export levels, a deceleration in imports is likely to yield beneficial effects on the current account.

The Effects of Income Taxation: Indonesia Case

This study rigorously evaluates the effects of Indonesia's income taxation on pivotal macroeconomic variables and its repercussions on the distribution of consumption and leisure, utilising the Overlapping Generations (OLG) model. The findings indicate that a 20% reduction in the marginal labour income tax yields positive effects on output, aggregate consumption, capital stock, and labour supply; however, this reduction results in an increasing disparity in the distribution of consumption and leisure, thereby leading to a decline in overall welfare. Conversely, an increment in the marginal labour income tax by the same percentage engenders an equitable distribution of consumption and leisure, which counterbalances the decreases in output, aggregate consumption, capital stock, and labour supply, thus resulting in an enhancement of welfare. In the absence of a consumption tax, the marginal labour income tax is significantly elevated, which in turn leads to markedly lower macroeconomic variables. In this circumstance, the improvements in the distribution of consumption and leisure are insufficient to offset the declines in key macroeconomic indicators, consequently reducing overall welfare.

Distributional Effect of Public Education: Indonesia Case

This study evaluates the impact of the government's increased expenditure on public education on income distribution in Indonesia. Enhanced public education funding is anticipated to diminish inequality, provided that parents actively contribute to the development of their children's human capital through effective engagement. The influence of effective parental involvement is expected to outweigh direct educational interventions, resulting in a more equitable distribution. Conversely, scenarios in which parents do not significantly participate in their children's educational development yield varying outcomes. An increase in governmental public education spending may contribute to heightened inequality in such cases. In instances where parents lack sufficient effective time to educate their offspring, the indirect effects of social security prevail. This phenomenon illustrates how augmented public expenditure can reduce the net income after taxes and the social security allocations, thereby leading to a lower government transfer that exacerbates inequality.

Interbank Market with DSGE Model

In the present study, we have constructed a Dynamic Stochastic General Equilibrium (DSGE) model tailored to Indonesia's small open economy. This model is equipped with an interbank market mechanism designed to illustrate the financial frictions originating from the supply side of banking institutions. Banks engage in a portfolio optimisation process that involves a choice between channelling credit and investing in risk-free assets. Conversely, the financial frictions experienced on the demand side are represented through collateral constraints and financial accelerators.

The results of the simulation indicate that disruptions in the interbank market will significantly impact the overall condition of banks, particularly concerning bank capital, Capital Adequacy Ratio (CAR), and the loan-to-deposit ratio (LDR). The state of a bank's balance sheet is consequential to the performance of the real sector. Furthermore, this model effectively captures procyclicality and financial accelerators sustained by financial frictions within the economy, wherein Gross Domestic Product (GDP) experiences growth during expansionary periods, in contrast to scenarios devoid of financial frictions. Conversely, during contractionary phases, GDP tends to decline. In response to economic downturns, banks are likely to curtail lending activities due to heightened risks, consequently elevating bank lending rates and making it increasingly difficult for entrepreneurs to secure financing. This situation places additional pressure on banks’ lending practices to mitigate the potential erosion of their capital.

The simulation results indicate that a shock, manifested through a combination of monetary and macroprudential policies, will exert a more profound suppression of credit growth in comparison to scenarios devoid of macroprudential policies. Although GDP and inflation experienced a decline, the changes were minimal when juxtaposed with scenarios that utilized solely the Bank Indonesia rate policy. The implementation of the policy mix has effectively mitigated the decline in consumption through a corresponding reduction in imports, thereby contributing to a relative stability in GDP. Furthermore, the policy combinations have also yielded stable inflation rates.

Balance of Payment Indonesia Model

This study has developed the Balance of Payments Indonesia Model for Assessments utilising a simultaneous equation approach. The two-step Error Correction Model (ECM) econometric method is employed to estimate all equations. The modelled components have been elaborated upon in greater detail, particularly regarding the current account block, thereby facilitating a clearer narrative for users of the model.

The results of the simulation indicate that the model is consistent with established economic theory. Furthermore, the forecast error associated with the model is relatively minimal, particularly concerning the components in the current account section. The incorporation of simultaneous equations within the model facilitates the examination of how changes in the current and financial accounts influence other macroeconomic variables. Despite the model's complexity, which involves numerous equations, it has been developed through the automation of data input, estimation, and model execution, thereby minimising the challenges associated with maintaining the consistency of relationships among the variables within the model.

The Determinant of Core Inflation in Indonesia

This paper conducts a comprehensive analysis of the factors influencing core inflation in Indonesia through the application of the Ordinary Least Squares (OLS) model and the utilization of quarterly data (quarter-to-quarter). It is posited that in the aftermath of the 1997/1998 economic crisis, core inflation was significantly affected by historical (backward-looking) core inflation, inflation expectations as represented by consensus forecasts, the output gap, the exchange rate (including both changes and levels of volatility), and the growth of M1 money supply. In comparison to the entirety of the sample period (1992-2011), the significance of the output gap increased substantially during the period following the economic crisis. Additionally, the exchange rate pass-through diminished, while the impact of exchange rate volatility became more pronounced. Through the implementation of the Multivariate (MV) filter on the output gap, it was determined that a threshold output gap emerged subsequent to the crisis period.

Simultaneously, the influence of the policy rate (Bank Indonesia rate) on mitigating core inflation is comparatively limited. Utilizing the Autoregressive Distributed Lag (ARDL) model and monthly data (Year-on-Year) from January 2002 to June 2011, we contend that the fluctuations in administered price inflation and volatile food inflation significantly affect the movement of core inflation in Indonesia. Generally, the effect of increases in volatile food items on core inflation is more pronounced than the effect of increases in administered prices. Several commodities subject to administered pricing, such as gasoline, urban transportation, household fuel, and telephone tariffs, have a notable impact on core inflation. Conversely, the volatile food items that have significantly influenced core inflation include rice, beef, milk, noodles, and cooking oil.

Output Gap Estimate in Indonesia

This paper provides an estimation of the output gap in Indonesia on a national scale and across seven provinces, specifically Jakarta, West Java, Central Java, East Java, Bali, West Sumatra, and South Sumatra. The estimation employs a multivariate (MV) filter, an adjusted Hodrick-Prescott filter, and a peak-to-peak method for the period from 1990 to 2011.

In general, the findings regarding the national output gap at the conclusion of 2011 indicate a negative value, suggesting that the actual level of output remains below its potential. Nevertheless, the trajectory of the output gap exhibits an upward trend, approaching zero. The fluctuations of the output gap across the majority of provinces also reflect an increasing pattern. The behaviour of real GDP in Indonesia following the 1997/1998 crisis appears to align with its trend and does not exhibit an extended cyclical pattern. Consequently, the variations in the output gap are concentrated around zero, ranging from -1.3% to 1.2%.

Despite the high degree of uncertainty inherent in the measurement of the output gap, the estimation derived from the Phillips curve demonstrates a significant correlation with the Consumer Price Index (CPI) inflation, applicable to both the entire observation period and the timeframe subsequent to the crisis. The methodology for calculating the adjusted output gap using the Hodrick-Prescott filter and the peak-to-peak approach, while straightforward, serves to enhance the insights provided by the MV filter output gap and other indicators in evaluating the state of the Indonesian economy.

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