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.

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