Organization of Chapters Introduction

6

1.2 Organization of Chapters

We will begin this thesis by providing a comprehensive summary of the major macroeconomic features of Indonesia along with recent developments in Chapter 2. Specifically, this chapter will discuss three major milestones affecting the Indonesian economy, namely, the primary oil boom from 1963 to 1980, the economic slowdown period in conjunction with global recession from 1981 to 1986, and the secondary boom due to economic recovery that was boosted by the surge in non-oil manufacturing exports that resulted from the FDI boom during 1987 to 1996. In addition to that, we will also discuss the impact on and significance of the Asian financial crisis in 1997 and 1998 to Indonesia. We will point out several major events since the occurrence of Asian financial crisis that has led Indonesia to experience policies reform. This discussion is necessary since it provides crucial background for the rest of the study. In essence, we will argue that it was weak macroeconomic fundamentals that were responsible for the economic turmoil during the Asian financial crisis as opposed to the alternative view that argued for contagion effects across ASEAN economies. Our view leads us naturally to the construction and simulation of an SSMM so as to capture the inter-relationships between key macroeconomic variables and, based on that, to suggest measures to bring about improvements through appropriate policy responses. Chapter 3 will be devoted to a discussion of the theoretical underpinnings of a small scale macroeconomic model. This chapter will first look at several variants of SSMM along with monetary policy rules. It will be followed by a comparison of their 7 respective merits and suitability for modeling the Indonesian economy. We will pay particular attention to the Batini-Haldane 1999 model that has been developed at the Bank of England and used recently in several countries such as Brazil and Venezuela. The model embodies forward-looking expectations of rational agents in the economy, which is preferable because they are solved using model-consistent rational expectations and hence immune to the Lucas critique. We will then supplement the discussion of the Batini-Haldane 1999 model with alternative monetary policy rules such as the Taylor 1993 and McCallum 1988 rules. Modelling the Indonesian economy using the small scale macroeconomic model will be the main focus of Chapter 4. In particular, this chapter will deal with the modification of the theoretical model i.e. the Batini-Haldane model to suit Indonesia’s macroeconomic structure and circumstances. We will also review Bank Indonesia’s small macroeconomic model, the BI-SQM, in this chapter. Furthermore, we have a subsection that deals with the inflation transmission mechanism in Indonesia in view of the emergence of an inflation-targeting regime in Indonesia recently. This is followed by a detailed discussion of Indonesian monetary policy before and after the Asian financial crisis that serves as a prelude to the specification of monetary policy rules in the Indonesian SSMM. Chapter 5 will initially deal with the estimation of the SSMM. This chapter will discuss alternative estimation methods thoroughly. It also briefly introduces the datasets and variables required for our estimation and policy simulations. We list the sources of 8 the data in the Data Appendix. The main purpose of Chapter 5 is to analyze and interpret the estimation and simulation results from the Indonesian SSMM. After estimating the model, we construct a baseline scenario for the Indonesian macroeconomy prior to conducting economic scenario analysis and policy simulations. We then study the monetary policy transmission mechanism through the simulation exercises with an aim to understand better how to achieve sustained non-inflationary economic growth in Indonesia with prudent and effective macroeconomic stabilization policies. Our investigations will use the baseline scenario as a benchmark against which the simulated scenarios will be compared. Chapter 6 concludes the thesis by summarizing the main findings, drawing the policy implications, and making suggestions for further research. Specifically, it proposes certain monetary policy measures that can provide guidance on the best responses from Indonesian policymakers. All in all, we hope that the future direction for the Indonesian economy can be illuminated by the policy actions that we suggest in this study. At best, it is hoped that Indonesia can find her way again to “sail to the dreamland of prosperity”. 9

Chapter 2 Macroeconomic Developments of Indonesian Economy