Inflation targeting

With the forced floatation of the exchange rate in mid-August 1997, Indonesia had lost its nominal anchor for monetary policy under ‘exchange-rate targeting’ and was therefore in need of a replacement target for price stabilization. Under IMF-supported stabilization programmes, it opted for monetary-base targeting, which served its initial objective of stabilizing inflation during the early phase of economic recovery. Although inflation had been brought down sharply by 2000, the economy did not fully recover until 2004. Bank Indonesia introduced ‘inflation targeting lite’ ¹ in 2000 as a precursor to fully fledged inflation targeting, which was introduced in July 2005. During the phase of inflation targeting lite (2000–04), the monetary base was used as the operational target ² to achieve the targeted annual rate of inflation. However, inflation performance was unsatisfactory, with the actual rate of inflation deviating from the targeted rate by a wide margin (Table 12.1). Bank Indonesia (2005) suggested two reasons for the poor performance of monetary base targeting. First, the money base–inflation relationship weakened following the currency–financial crises. Second, the monetary base was a technically intractable variable in the circumstances, not amenable to control.