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Central Bank Credibility and Monetary Policy: Evidence from Small Scale Macroeconomic Model of Indonesia

Enrico Tanuwidjaja () and Keen Meng Choy ()
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Enrico Tanuwidjaja: Singapore Centre for Applied and Policy Economics, Department of Economics, National University of Singapore

SCAPE Policy Research Working Paper Series from National University of Singapore, Department of Economics, SCAPE

Abstract: In this paper, we develop a forward-looking small scale macroeconomic model (SSMM) of the Indonesian economy which is potentially useful for carrying out monetary policy analysis. The Batini-Haldane (1999) model is used as the theoretical underpinning for the development of the model along with the well -known Taylor policy rule (1993). The tracking performance of the model is found to be satisfactory. We conduct deterministic and stochastic simulations to examine the role of the central bank’s credibility in achieving the inflation target and to suggest appropriate monetary policy responses. Policy simulations indicate that it is crucial for the Indonesian authority to address its credibility for Indonesia to achieve a lower inflation rate. Simulations to trace out the inflation-output tradeoff frontier also show that a monetary policy rule that targeted both the inflation and output gap will result in less macroeconomic volatility. We also found that the inclusion of the exchange rate into the monetary policy rule as an additional feedback variable warrants serious consideration in the future course of monetary policy management.

Keywords: Small Scale Macroeconomic Model; Monetary Policy; Central Bank Credibility; Policy Frontier; Indonesia (search for similar items in EconPapers)
JEL-codes: C15 C51 E17 E52 O53 (search for similar items in EconPapers)
Date: 2005-11
New Economics Papers: this item is included in nep-cba, nep-mac, nep-mon and nep-sea
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