The transmission mechanisms of monetary policy in Indonesia

Abstract

A major change in the conduct of monetary policy in Indonesia in the aftermath of the 1997– 2000 crisis was Act no 23/1999 and its revision in Act no 3/2004 that gives Bank Indonesia full autonomy in formulating and implementing policies. First, the objective of the central bank focuses on achieving and maintaining the stability of the rupiah (currency) value, meaning inflation and exchange rate.2 Second, the central bank has been given independence in conducting its monetary policy (ie determining the monetary instrument used in monetary management), while the government in coordination with the central bank will set the inflation target. Third, the decision on monetary policy rests with the Bank Indonesia’s Board of Governors, without any intervention from the government or other parties. And fourth, a clear mechanism for accountability and transparency of monetary policy is outlined in the Act, inter alia by requiring Bank Indonesia to announce its inflation target and plan of monetary policy at the beginning of the year and to provide a quarterly report to the Parliament for its conduct of monetary policy. Against the background, we argue that the most suitable framework of future monetary policy for Indonesia is inflation targeting. Two fundamental prerequisites for inflation targeting – ie, the ability to conduct monetary policy with independence and the

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