Peer reviewed analysis from world leading experts

Indonesia’s inflation outlook

Reading Time: 2 mins

In Brief

Indonesia’s inflation rate is now well over twice as high as the central bank’s target of about five per cent. There are two convenient scapegoats: big increases in both oil and rice prices. But the real explanation, as always, is unduly loose monetary policy.

Such an assertion will seem implausible, perhaps, to most observers. After all, Bank Indonesia has increased interest rates in recent months, which seems to suggest a tightening of monetary policy. That can hardly be denied, but the fact remains that monetary policy still remains quite loose. The best indicator of this is the growth of currency in circulation, which has accelerated significantly over the last several months, and is now running at rates of almost 30% annually.

Share

  • A
  • A
  • A

Share

  • A
  • A
  • A

The reason why nominal interest rates have been increasing at the same time that money supply has been growing very rapidly, presumably, is that the demand for money has been growing even more rapidly. That is entirely to be expected, since the demand for money depends on the level of prices. Fuel and food prices are so important that significant increases in them must be expected to result in significant increases in the demand for money.

This is reminiscent of the early months of the late 1990s financial crisis in Indonesia. At that time, SBI rates increased dramatically from around 10% to a peak of about 70%, leading many observers to complain about “tight” monetary policy. But in fact monetary policy was anything but tight. On the contrary: currency in circulation almost doubled within only about nine months.

The problem for monetary policy makers if they choose to focus on interest rates (as is the case presently in Indonesia) is that it cannot be assumed that conditions are being tightened simply because nominal interest rates are rising. In the present case, the small increases in the policy rate in recent months have not been sufficient to bring monetary growth down to a level consistent with the current inflation target.

Having said that, whereas Bank Indonesia’s policy rate used to be the same as the 30 day SBI (Bank Indonesia certificate) rate, it is now about 50 basis points lower. In other words, the actual settings of monetary policy seem to be somewhat tighter than what has been announced. This suggests that Bank Indonesia is aware of the importance of pushing rates higher, while at the same time being reluctant to be seen to be doing so.

Nevertheless, the latest inflation reading appears to have been somewhat higher than expected. Don’t be surprised if inflation persists at a high level in the absence of further interest rate increases sufficient to reduce money growth significantly. Indeed, Bank Indonesia itself is now predicting that consumer price inflation will remain at about 12% through the end of this year.

Comments are closed.

Support Quality Analysis

Donate
The East Asia Forum office is based in Australia and EAF acknowledges the First Peoples of this land — in Canberra the Ngunnawal and Ngambri people — and recognises their continuous connection to culture, community and Country.

Article printed from East Asia Forum (https://www.eastasiaforum.org)

Copyright ©2024 East Asia Forum. All rights reserved.