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could be environmentally destructive, which will enable the authority to oversee the environmental risk contributed by the banking sector. This way BI can observe the
banking sector’s overall operational risk related to the environment and help the domestic banking sector comply with international standards governing environmental
protection.
From another perspective, one may consider also how financial markes can foster adaptation to climate change. Some arguments state that the financial markets’
capacity to realllocatae costs and risks will help reduce the social costs of adaptation. Two types of financial instruments which are commonly used to respond climate
change are ‘weather derivatives’ and Catastrophe bonds. In Asia, not many countries have developed these instruments. Indonesia itself has not been using hedging
instruments against weather and catastrophic risks. For a further policy option, traditionally, Indonesia has been adopting a self-hedging policy by strengthening
financial system and building financing structure mechanisms to protect domestic economy from the price risks.
4.2.2. M onetary Policy
High inflation due to rising food and oil prices has caused dilemmatic condition for economic growth in Indonesia. On one side, efforts to overcome inflation in the
short term can curb economic growth. However, on the other side, economic growth is required to increase the population’s income to guarantee purchasing power. This
condition is in accordance with the existence of
Philips Curve
in Indonesia that shows a more inelastic trade-off between economic growth and inflation in the post crisis
period Solikin, 2004. This empirical fact indicates that for demand stimuli not to generate excessive inflationary pressures, demand management policy must be
complemented by the mitigation of capacity constraints on the supply side, such as through legal, institutional and infrastructure improvements.
Meanwhile, the increasing independence of central banks since 1999 and the growing adoption of price stability objectives, often based on inflation targeting, have
helped to improve the response of monetary policy, and price-setting behavior more generally, to oil price shocks. In particular, inflation targeting, has helped to anchor
inflation expectations among economic agents, preventing temporary inflationary shocks from becoming embedded into a more generalized and enduring increase in
the inflation rate.
As the weight of food within consumer price baskets is quite large around 38 percent, inflation expectations have been affected contemporaneously by the current
oil and commodity shocks. As a result, it is now generally accepted that transitory spikes in headline inflation caused by movements in commodity prices cannot be
ignored. Thus, from the standpoint of BI, it might be necessary for nominal interest
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rates to respond to headline inflation in order to reshape inflation expectations. Furthermore, monetary policy must be vigilant towards any second-round inflationary
effects that show up in core inflation China and Korea. For emerging economies with currencies closely linked to the US dollar, movement towards a more flexible
exchange rate regime could also provide greater scope for effective and stable monetary policy action as China.
4.2.3. Fiscal policy
