Sources and dynamics of inflation

In the low-inflationary Asia-Pacific region, Indonesia is considered an inflation-prone country. This is largely because of Indonesia’s inflation experiences during the 1950s and early 1960s when ongoing high and volatile inflation took it to the verge of ‘near-hyperinflation’ and economic collapse. ¹ Most economists, writing on Indonesia’s economy, have subscribed to the view that this inflationary episode had fiscal-monetary roots (Mackie, 1971). The political change in 1966 and the subsequent stabilization and economic reforms combined to bring inflation to single-digit level within a remarkably short period of time. In the three decades from the late 1960s to the late 1990s, Indonesia’s inflation has remained at a moderately high level, on average within the range of about 10–12 per cent per annum, except during three high-inflationary episodes provoked by supply or external shocks. The first episode arose from the 1973–74 OPEC oil shock when the inflation rate rose to about 35 per cent per annum. The second OPEC oil shock of 1979–80 pushed Indonesia’s inflation up to about 20 per cent per annum. The third episode of high inflation originated in the East Asian currency–financial crises of 1997–98. This economic tsunami disrupted Indonesia’s economy, and later its society and polity, more seriously than any other shock, including the 2007–08 US-originated global financial crisis. During the peak of the currency–financial crises in 1997–98, Indonesia’s annual inflation rose to about 60 per cent. Fortunately, the phenomenon was transitory and did not lead to hyperinflation, as many had feared it would, presumably because a set of IMF-supported stabilization policies were already in place. ²