ABSTRACT
Chapter 5 has analysed the inflationary process in Indonesia dating from the early 1950s. There is consensus that Indonesian inflation in the 1950s and early 1960s originated from expansionary fiscal and monetary policies. Using annual data for the period 1970–2009, Chapter 5 investigated the sources and dynamics of inflation within a cointegration–error-correction modelling framework. The key finding is that money, output and prices maintained a weak cointegral relationship in Indonesia during this period. Although no major structural breaks were detected in the relationship over the study period, the expectation is for money, output and prices to form a stronger relationship in the future, in view of the fact that the country has been operating under a managed-floating exchange-rate system since the currency– financial crises of 1997–98. Another important characteristic of inflation in Indonesia is that it remains highly volatile. Although the introduction of rule-based monetary policy since the currency–financial crises has lowered inflation, it has remained unsteady. This could be a reflection of Bank Indonesia’s low credibility in controlling inflation. Both domestic and external shocks also have a major impact on inflation uncertainty because under a managed-floating exchange-rate system the role of the exchange rate in neutralizing shocks to the economy has been diminished. The question remains whether the decline of inflation and any changes in its volatility were due to changes in monetary policy regimes, or were caused by other factors, including the impacts of random shocks.
