00074918.2013.850630
Bulletin of Indonesian Economic Studies
ISSN: 0007-4918 (Print) 1472-7234 (Online) Journal homepage: http://www.tandfonline.com/loi/cbie20
Inflation targeting in Indonesia, 1999–2012: an expost review
Lloyd R. Kenward
To cite this article: Lloyd R. Kenward (2013) Inflation targeting in Indonesia, 1999–2012:
an ex-post review, Bulletin of Indonesian Economic Studies, 49:3, 305-327, DOI:
10.1080/00074918.2013.850630
To link to this article: http://dx.doi.org/10.1080/00074918.2013.850630
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Date: 17 January 2016, At: 23:48
Bulletin of Indonesian Economic Studies, Vol. 49, No. 3, 2013: 305–27
INFLATION TARGETING IN INDONESIA, 1999–2012:
AN EX-POST REVIEW
Lloyd R. Kenward*
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Victoria, Canada
Around the end of 1999, Bank Indonesia (BI) adopted inlation targeting as part
of its approach to monetary policy. This article reviews the experience up to 2012,
examines BI’s performance in hitting its inlation targets and considers certain
broader indicators of success. Overall, inlation targeting in Indonesia has been a
messy, evolutionary process, and BI’s implementation record compares unfavourably with that of its peers. Yet Indonesia recorded a signiicant downward trend in
inlation during this period and maintained strong economic growth. Also, almost
all of its inlation-targeting arrangements are now in line with common international practice. Looking ahead, this article offers suggestions for sustaining progress in inlation targeting, such as setting more ambitious targets in the outer years
and implementing strong policies to reduce inlation further, including after large
administrative price shocks.
Keywords: inlation targeting, monetary policy
INTRODUCTION
Indonesia has a well-known history of being prone to inlation (Hossain 2012:
111–17). Since independence, in 1945, the only extended period of reasonable stability was 1985–96, when the inlation rate, as measured by the consumer price
index (CPI), was generally in high single digits, averaging almost 8%.1 Against
this background, three developments in the late 1990s foreshadowed change.
First, in mid-1997 the authorities abandoned their ‘crawling band’ exchange-rate
regime, substituting the IMF- and crisis-driven model of targeting base money to
reach desired rates of nominal GDP and, in effect, inlation. Second, in May 1999
the Indonesian parliament enacted Law 23/1999 on Bank Indonesia (BI), which
deined relatively clearly the central bank’s objective2 and, in principle, granted
* The author wishes to acknowledge the many helpful comments of two anonymous
referees. Their suggestions signiicantly improved the quality of this article.
1 Source: .
2 Article 7 states that BI’s objective ‘is to achieve and maintain stability of the rupiah value’. At the time, it was unclear whether this was intended to mean low inlation or stability
in the exchange rate. BI’s mission and vision statements clearly prioritise low inlation (see
the preface to any of BI’s annual or economic reports from 2001 to 2011).
ISSN 0007-4918 print/ISSN 1472-7234 online/13/030305-23
http://dx.doi.org/10.1080/00074918.2013.850630
© 2013 Indonesia Project ANU
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Lloyd R. Kenward
BI suficient independence to achieve it (Alamsyah et. al. 2001), with provisions
for accountability (in chapter X of the law). And third, in 1999 BI adopted inlation
targeting, and it announced its irst targets in early 2000 (table 1).
Indonesia has had 13 years’ experience with various forms of inlation targeting, and there have been many changes during this period, including critical institutional developments (table 1). This article examines this experience, providing
international evidence and comparisons, where appropriate. It begins by reviewing developments during the inlation-targeting period to 2012, presenting BI’s
targets and outcomes in ive distinctly different sub-periods. This portion of the
article includes a discussion of BI’s policy reactions at critical times, especially
after it abandoned the growth rate of base money as its primary policy instrument, in 2005. The subsequent sections summarise BI’s record from two perspectives: the irst is a narrow, technical analysis of the authorities’ success in hitting
their targets; the second takes a broader view of BI’s accomplishments in inlation
targeting. The concluding section looks ahead and suggests ways of sustaining
Indonesia’s progress in managing inlation.
For analytical purposes, this article makes certain assumptions about oficial
inlation targets, and the weaknesses of these assumptions should be noted at
the outset. First, the analysis presents intra-year inlation targets as bands whose
end-point is deined by the target and whose starting mid-point is deined by
the actual December inlation (CPI) rate for the previous year. Oficial inlationtargeting statements and analysis are rarely explicit about intra-year targets,
although examples of this article’s approach exist in oficial documents (see, for
example, BI 2007: 84, chart 3), as do references to ‘target corridors’ (italics added).3
Second, policymakers focus mainly on their year-end forecast in relation to the
year-end target, but it is dificult to gather reliable data on the evolution of BI’s
year-end forecasts during most of this inlation-targeting period. Consequently,
this article’s comparison of CPI outcomes with the target in any given year should
be interpreted only as a reasonable proxy for BI’s assessment of ongoing developments at the time.
Nor is this article a primer on inlation targeting; it mentions the basics of the
policy only when necessary. A case in point concerns how BI responds to differences between its targets and actual inlation. BI has been relatively clear on
this subject,4 and this article inds that BI has followed its announced approach,
with only a few exceptions. For example, the decision to tighten policy (and
to what degree) depends in large part on BI’s forecast for inlation based on
unchanged policies, balanced against pressures to pursue other policy goals, such
3 See BI (2008: 120; 2009: xvii, 169; 2010: xx, xxi, xxv, 3). Table 11.9 in BI (2002: 215) presents
an indicative, linear target path for 2003–06, which is consistent with this article’s analysis.
4 Namely, ‘Any change in the monetary policy stance is undertaken after evaluating
whether future developments in inlation are on track with the established inlation target …. At the operational level, the monetary policy stance is relected in the setting of
the policy rate (BI Rate) with the expectation of inluencing money market rates and in
turn the deposit rates and lending rates in the banking system. Changes in these rates will
ultimately inluence output and inlation.’ See . See also the discussion in the text, under ‘A new beginning: 2004–06’.
Inlation targeting in Indonesia, 1999–2012: an ex-post review
307
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TABLE 1 Critical Institutional Developments in Inlation Targeting in Indonesia
May 1999
Parliament enacts Law 23/1999 on Bank Indonesia, granting the central
bank more independence to meet its objectives.
January 2000
Bank Indonesia announces its irst oficial inlation targets, for 2000.
April 2003
Law 17/2003 on State Finance requires that the government and Bank
Indonesia coordinate their monetary and iscal policies.
July 2003
The government decides to end its IMF assistance program.
January 2004
An amendment to Law 23/1999 shifts the responsibility for setting the
inlation targets to the government (with Bank Indonesia).
February 2004
Name of Bank Indonesia’s annual report changed to Economic Report on
Indonesia with release of 2003 report.
July 2004
The government and Bank Indonesia sign an MOU on the process for
setting, monitoring and controlling inlation targets.
September 2004 The Ministry of Finance issues a decree setting the government’s irst
inlation targets, for 2005–07.
July 2005
Bank Indonesia launches its new inlation-targeting framework, using
interest rates as its instrument and signal.
Note: MOU = memorandum of understanding.
as sustaining growth or maintaining inancial-sector stability.5 In addition, and as
discussed later, the instruments for tightening policy have changed over the years
and have on occasion invoked regulatory policy. Also, and most importantly for
this article, a central bank can reduce inlation with less impact on aggregate output by lowering inlationary expectations. This is a well-known and simple idea:
if a central bank is credible in its intentions to reduce inlation, disinlation is less
costly, and it is easier to hold inlation down once it is low (Blinder 2000: 1430–
1). The operative word here, however, is credible; to gain credibility in its policy
announcements, BI needs to establish a reputation for delivering its announced
policies. And herein lies the main contribution of this article: namely, a detailed
review of BI’s record in inlation targeting.
STARTING THE PROCESS: 1999–2001
BI undertook inlation targeting at a juncture of considerable uncertainty (Cameron 1999: 9–10). Inlation (as measured by the 12-month CPI) had been luctuating widely, owing to the 1997–98 Asian inancial crisis, and peaked at more than
80% in the second half of 1998. In the inal months of 1999, when decisions were
being made about the irst target within the context of Indonesia’s IMF program,
inlation was decelerating sharply, restrained by a 50% rebound in the value of the
rupiah from its low point in mid-1998 (BI 1999: chart 3.9). In recognition, in early
2000 BI put its irst target (igure 1 and appendix table A1) on a steeply rising path
and for only one year – that is, for 2000. BI was targeting core inlation at this point
(that is, inlation excluding the impact of the government’s price and income poli-
5 This is consistent with Alamsyah et. al. (2001).
Lloyd R. Kenward
308
FIGURE 1 Inlation and Bank Indonesia’s Upper and Lower Targets, 1999–2006
(% p.a.)
25
20
12-month CPI
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15
10
5
0
Jun-1999
Oct-2000
Feb-2002
Jun-2003
Oct-2004
Feb-2006
Source: Appendix table A1.
cies (BI 2000: xiv, 155)). The targets in igure 1 use headline inlation, for the sake
of comparability with the actual CPI.
Determining the desirable time horizon for inlation targeting normally
involves assessing the lag between decisions on monetary policy and their impact
on inlation.6 One year looks too short to be credible. Still, countries commonly
set one-year targets, especially when using disinlationary strategies during the
early stages of inlation targeting (Hammond 2012: 9; Roger 2009: 5), and in 1999
Indonesia was still in a disinlationary stage. But it is unconventional to announce
a steeply rising target, which does little to contain inlationary expectations, especially when actual inlation overshoots the target, as it did in 2000 (igure 1). This
combination made for an uncertain start to inlation targeting in Indonesia.
BI’s second target, for 2001, aimed at a declining rate of inlation (igure 1 and
appendix table A1). It also widened the expected range for headline inlation by
0.5 of a percentage point (appendix table A1), which was appropriate because of
ongoing volatility. Like the 2000 target, however, the 2001 target set only a oneyear time horizon. In the event, inlation rose steadily throughout 2001 (igure 1)
and inished the year well above BI’s target.
After only two years, BI’s inlation-targeting regime was at risk. To be sure, it is
not unusual for countries to have trouble achieving their inlation targets during
the early years of inlation targeting (Roger 2009: 14). But international econometric evidence (Roger 2009: 16) shows that a central bank’s missing its targets during
disinlation weakens its policy credibility. This is consistent with the Indonesian
experience; these early years set the stage for the reforms of 2004, which would
spread the responsibility more widely within the government.
6 BI research (BI 2000: 160) shows that monetary policy needs more than one year to affect
the real economy. Seasonal or cyclical factors also need time to unwind, including those
(such as Ramadan) that are not fully captured in a 12-month calculation of inlation.
Inlation targeting in Indonesia, 1999–2012: an ex-post review
309
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Commenting on this uncertain start to inlation targeting, Syahril Sabirin, the
BI governor at the time, provided some insights in his foreword to BI’s Annual
Report for 2001. To summarise, Indonesia was still reeling from the 1997–98 crisis, and the governor argued that, in such circumstances, BI could not be held
responsible for its legal mandate ‘to achieve and maintain stability of the rupiah’s
value’. Yet this researcher found no oficial answer to why BI took on a major task
such as inlation targeting at such a risky juncture.7 Perhaps it was deemed more
important to begin the process than to achieve short-term results, which would be
consistent with BI’s next steps.
A LONG-TERM PERSPECTIVE FOR A SHORT WHILE: 2001–03
Having had only limited success with one-year inlation targets, BI changed its
strategy, beginning with its targets for 2002. It moved to a more conventional, gently declining long-term target (igure 1 and appendix table A1) that incorporated
several notable features. BI changed to targeting headline inlation for the sake of
transparency and in response to changing public expectations (BI 2001: ix), which
brought Indonesia into line with international practice (Hammond 2012: 9). Also,
BI set a longer-term target,8 from 2002 to 2006 (igure 1),9 but abandoned it in 2004.
The 2006 target was only 6%–7%, which is not much lower than the 8% recorded
during the ive years of economic boom immediately before the 1997–98 crisis. BI
also narrowed the width of the target from two percentage points to one, for reasons that remain unclear. Few countries have used a target range as narrow as this
(Hammond 2012: 9), and given BI’s record for 2000 and 2001 a wider range would
have been a better choice.
Nevertheless, as 2002 unfolded, BI seemed to be making progress. Inlation
came down quickly during the irst half of the year and even fell below BI’s targets
for a short while (igure 1). By year-end, inlation was only slightly above target.
For all practical purposes, BI had scored its irst success with inlation targeting.
This success continued throughout 2003 and most of 2004 (igure 1), but questions soon arose about the exact targets. For example, BI’s economic report for
2002 states that BI stuck with its long-term perspective (of 6%–7% for 2006) but
reduced the time horizon from ive years to four years. Also, the target for the
7 The best answer was found in Goeltom (2007: 146) – namely, that a tight target speciied
for a short, one-year time horizon would help to restore BI’s credibility, provided that the
target could be achieved (italics added). In light of actual inlationary developments, Goeltom argued that BI was constrained by both supply shocks (oil and electricity prices) and
demand shocks (civil-service wage increases). This is consistent with the BI governor’s
explanation noted in the text.
8 The cautious wording is notable: ‘In the next ive years Bank Indonesia has committed
to gradually lowering the inlation rate to around 6%–7%’ (author’s translation from the
Bahasa Indonesia version, BI 2001: ix).
9 This is surprisingly long, for several reasons. First, the jump from a one- to a ive-year
time horizon is large. Second, ive years is considerably longer than the time required for
monetary policy to have an impact (generally understood to be one to two years). And,
third, few countries operate with a time horizon as long as ive years, although several
use a ‘medium-term approach’ (interpreted as two years or more) or have an ‘at all times’
perspective (Hammond 2012: 9).
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Lloyd R. Kenward
irst year was unchanged, but it was delayed by one year (from 2002 to 2003), and
the report is somewhat ambiguous about the width of the 2003 target.10 Notwithstanding its recent successes, BI was, in effect, announcing that it expected not
to accomplish much more during 2003 but to reduce inlation by another two to
three percentage points over the next three years.
Other important events were unfolding around this time, and these may have
reduced BI’s commitment to lowering inlation. For example, intense negotiations
were underway about revising Law 23/1999 on BI, and about other matters, such
as the recovery of Bank Indonesia Liquidity Assistance loans made to troubled
commercial banks during the 1997–98 crisis. BI acknowledged that these circumstances hampered its performance of its duties (BI 2003: xxi), and they eventually
erupted into a major scandal (Kong and Ramayandi 2008: 30–1). Also, national
elections were looming in the irst half of 2004, and policymakers were deferring
important decisions on fuel prices (Marks 2004: 165).
CONFUSION AND CHANGE: 2003–04
During 2003–04, Indonesia introduced many changes to its institutions and processes, apparently in search of a more effective inlation-targeting system. The
enactment of Law 17/2003 on State Finance, for example, required that the government and BI coordinate their iscal and monetary policies (Ginting 2003: 355).
And, in June 2004, elucidation 4 to the amendment to Law 23/1999 shifted the
responsibility for setting inlation targets from BI to the government.11 Inlation
targeting was now, in effect, a joint exercise.
In implementation, in May 2004 BI submitted its proposed inlation targets to
the government (BI 2004a). Also, on 1 July 2004 the government (represented by
the Minister of Finance) and the BI governor signed a memorandum of understanding (MOU) on the process for setting inlation targets and on monitoring
and control. The MOU did more than simply set the inlation targets: it established
a coordinating mechanism and deined the respective roles of the government
and BI in targeting, monitoring and controlling inlation,12 in providing public
information and building public conidence, and in promoting transparency and
10 BI (2002) ‘sets the inlation target for 2003 at 9% with a 1% error margin’ (p. 18). It is unclear whether this means 8.5%–9.5% or 8%–10%. The former looks more plausible, because
it would have been consistent with the 2006 target of 6%–7% (the target presented in igure
1). BI (2003: 53) says that the target at the beginning of 2003 was 9% with a deviation of
+/– 1%. This is strange, however, because it implies a narrowing target width from 2003 to
2006. In the event, it matters little – actual inlation remained well below both targets until
they were superseded, in September 2004 (see later in the text).
11 Neither the amendment nor the elucidation is speciic about the means that BI must
use to achieve this goal. They refer both to monetary targets and to other means, such as
open-market operations, discount rates, bank reserve requirements and credit regulations.
Elucidation 3 explicitly maintains the dichotomy (see footnote 2) that BI’s responsibility
for maintaining the rupiah’s value includes both stable prices and a stable exchange rate.
12 The MOU provides wide leeway for certain details of the targets. They can be set in terms
of headline or core CPI inlation, and they can be a range, a point or a point with deviation.
Inlation targeting in Indonesia, 1999–2012: an ex-post review
311
FIGURE 2 Authority for Setting Inlation Targets
(number of countries)
20
18
16
Bank Indonesia
Hammond’s State of the Art in Inflation Targeting
14
12
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10
8
6
4
2
0
Government
Central Bank
Both
Source: BI (2004: 19); Hammond (2012: 8).
accountability in economic policy.13 The MOU also included a commitment from
the government to adopt an inlation target before the end of July. In the event,
this did not occur until September 2004 (table 1).
Broadening institutional responsibility was a healthy step forward (mainly
because of BI’s spotty record in inlation targeting up to that point) and sought
to coordinate Indonesia’s monetary and iscal policies. It was – and, increasingly,
is – common international practice for a broader constituency to set a country’s
inlation targets (igure 2). There was also a matter of personalities. Some key individuals involved in the MOU had worked both as central bankers and in other
capacities, including as cabinet ministers. Consequently, they had a wider, crossinstitutional perspective and were, therefore, more supportive of broader institutional responsibility.
Subsequent changes to inlation targeting were determined largely by the
MOU. Following its signing, the government and BI set up the interdepartmental
Inlation Control Team (Tim Pengendalian Inlasi, TPI; BI 2004: 20; BI 2005: 85),14
which was tasked with improving coordination between BI and the Ministry of
Finance at the technical level. Its role included recommending inlation targets,
13 The Ministry of Finance Decree of 6 September 2004 included, in article 3, an explicit
provision for accountability: ‘Bank Indonesia and the government will openly explain to
parliament and the public the causes of failing to achieve the inlation target’ (author’s
translation).
14 The TPI seems to have started operating in 2005. In due course, members included BI,
the Ministry of Finance, the Coordinating Ministry for Economic Affairs, the Ministry of
Trade, the Ministry of Communications, the Ministry of Energy and Mineral Resources, the
National Development Planning Agency, the Ministry of Agriculture, and the Ministry of
Labour and Transmigration (BI 2010: 39).
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Lloyd R. Kenward
evaluating sources of potential inlationary pressure and their implications for the
targets, advising on policies for achieving the targets, and disseminating information to the public. In 2008, the TPI was expanded to include Regional Inlation
Control Teams (Tim Pengendalian Inlasi Daerah, TPIDs).15
Oficial statements about inlation targets continued to lack clarity, however,
with different targets and projections being cited at different times.16 For example,
BI’s Economic Report on Indonesia for 2003 states that ‘monetary policy in 2004 will
continue to be directed at achieving the medium-term inlation target of 6% in
2006’ (BI 2003: 17).17 Yet, in a press release, BI (2004a) indicated that monitoring
and control of inlation for 2004 would be guided by BI’s inlation projection (italics
added) for that year. This projection is deined in BI’s Economic Report on Indonesia
for 2004 as 4.5%–6.5%, where it is sometimes referred to as ‘a target’ (BI 2004: xviii,
50).18 In the event, inlation soon accelerated, reaching 6.4% in December 2004,
compared with 5.1% a year earlier.
A NEW BEGINNING: 2004–06
On 6 September 2004, the government issued its irst inlation target, for 2005–07
(igure 3). It adopted a mainstream approach to targeting headline CPI inlation
– namely, by setting a gently declining target path with a three-year time horizon, expressed as a point with a tolerance range of two percentage points, in line
with common international practice (Hammond 2012: 9). This was promising, but
within months the new approach faced its irst test, as inlation quickly moved
outside the target range (igure 3). Soaring international oil prices forced two
large increases in domestic fuel prices, in March (McLeod 2005: 140) and October
(Sen and Steer 2005: 285). BI estimated the immediate impact on the CPI at 3.75
percentage points (BI 2005: 27), and inlation came under additional near-term
pressure from the exchange rate, especially after mid-2005 (BI 2005: 59). Yet the
authorities responded well, using interest rates, supported by the aggressive use
of regulatory policy,19 to contain follow-on inlationary pressures and demonstrate their commitment to inlation targeting.
Amid this turbulence, BI took another important step in inlation targeting (BI
2004: 21). Following Indonesia’s decision in July 2003 to end its IMF program,
15 At irst, TPIDs were set up in only a few regions across Indonesia; by 2010, they were
operating in 53 regions (BI 2010: 39), apparently with the aim of covering the 66 urban areas
included in CPI calculations.
16 Given that there was no clear announcement for 2004, igure 1 does not include a formal
target for that year. Appendix table A1 notes the informal target of 5.5% +/– 1%.
17 Previously, the target for 2006 had been 6%–7% (appendix table A1).
18 There was no mention of the old 2006 target of 6%–7%. The report does refer to a 2004
target of 6%–7% for core inlation (BI 2004: 51), but this looks more like a projection than a
target. It seems coincidental that it is the same as the old target for 2006. Sarwono (2007) does
not cite an oficial 2004 target but indicates a target range of 4.5%–6.5% in one of his charts.
19 Regulatory policy reduced banks’ net open positions and strictly limited derivative
transactions (BI 2005: 70–2), mainly to protect the exchange rate. Also, the TPI was introduced (footnote 14), and there was ‘measured intervention’ in the foreign-exchange market
(BI 2005: 5).
Inlation targeting in Indonesia, 1999–2012: an ex-post review
313
FIGURE 3 Inlation and the Government’s Upper and Lower Targets, 2004–10
(% p.a.)
20
12-month CPI
15
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10
5
0
Jan-2004
May-2005
Sep-2006
Jan-2008
May-2009
Sep-2010
Source: Appendix table A1.
Note: The shaded bands represent the government’s implied stance on monetary policy (see also table
2), from tightening (dark grey) to easing (light grey) to neutral (unshaded) .
in July 2005 BI oficially moved from base money to interest rates as its operational target.20 In principle, the mechanism is simple. The so-called BI rate is set
as a ‘signal’ by BI’s board of governors,21 based on the performance of inlation
relative to the targets (BI 2005: 101). As envisaged, changes in the BI rate are then
relected quickly in the overnight interbank rate, in due course in other interest
rates (including bank lending rates), and ultimately in real activity and inlation.
Figure 4 shows the path of three key interest rates over the inlation-targeting
period.22 All have similar proiles, although the JIBOR is much more volatile during extended periods of tight (or easing) monetary policy. The broad stance of monetary policy, as indicated by the path of the rates in igure 4, is summarised in table
2 and superimposed on igures 3 and 5, to show BI’s policy responses to inlation.
The assessments in table 2 are relatively consistent with oficial BI statements, and
20 For a discussion of the considerations in choosing between base money and interest
rates, see, for example, BI (2004: 21) and Hossain (2012: chapter 7).
21 As envisaged (BI 2005: 102), the BI rate would be set quarterly (in January, April, July
and October), unless adjusted, in special circumstances, at other monthly BI board meetings. For all practical purposes, the BI rate has been set monthly.
22 The BI rate is a ‘signal’, as mentioned in the text; FASBI (Fasilitas Simpanan Bank Indonesia) is BI’s key short-term (overnight) policy rate; and JIBOR (Jakarta Interbank Overnight Rate) is a sensitive indicator of liquidity conditions in the interbank money market.
The overnight FASBI was inactive between April and September 2005, which accounts for
the gap in igure 4 (BI 2005: chapter 5). Figure 4 also uses the one-month Bank Indonesia
Certiicate (Sertiikat Bank Indonesia, SBI) rate before July 2005 (when the BI rate was introduced), in line with BI’s convention (BI 2005: chart 5.17).
Lloyd R. Kenward
314
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TABLE 2 Implied Stance of Monetary Policy
February 2004–April 2005
Neutral
Eased slightly
May 2005-April 2006
Tight
Tightened through December;
very tight through April
May 2006–December 2007
Easing
Unwound gently
January 2008–April 2008
Neutral
Perhaps eased slightly
May 2008–October 2008
Tightening
FASBI out of phase with Bank
Indonesia rate by 1 month
November 2008–August 2009
Easing
September 2009–September 2011
Neutral
Tightened in February 2011
(not signiicant)
October 2011–February 2012
Easing
Limited, compared with
previous periods
March 2012–December 2012
Neutral
Wide spread between Bank
Indonesia rate and others
Source: Author’s analysis of igure 5.
Note: FASBI = Bank Indonesia Deposit Facility.
policy adjustments tracked the CPI’s deviations quite well – especially after the
increases in fuel prices in 2005. The main exceptions, in late 2007–08 and in 2010,
when inlation surged above target, are worth emphasising at this point. In 2007–
08, BI was slow to raise interest rates, owing to concerns over the international
inancial crisis; in 2010, BI held interest rates steady, arguing – correctly – that the
surge was caused by volatile food prices, which would unwind in due course.
Much has been made of BI’s shift from base money to interest rates, including
calling it ‘fully ledged’ inlation targeting (Hossain 2012: 167; Hammond 2012:
chart 1), and contrasting it with the previous regime of ‘inlation targeting lite’
(Hossain 2012: 277). This article has a less dramatic interpretation, in part because
BI continues to refer to it, accurately, as a shift to a ‘lexible inlation targeting
framework’ (BI 2011: 81; see also ‘A wider perspective’, below). BI essentially
changed the instrument for achieving the same result, opting for the more transparent and easily understood instrument – interest rates.
Follow-up steps included setting a revised target for inlation for 2006–08,
which was announced on 17 March 2006 at a press conference called by the Economic Coordinating Minister. The new plan (appendix table A1) was to return
inlation within three years to the target envisaged before fuel prices had increased
in 2005 (igure 3). Effectively, this represented a setback of one to two years for
inlation targeting.
SETTLING IN: 2006–12
With the government’s strong policies in place, inlation came down quickly during 2006. By October that year, it had fallen below the government’s target, where
it generally stayed until mid-2007 (igure 3). As inlation fell, BI eased the BI rate
(igures 3 and 4) to a low point of 8% in late 2007, which it maintained through
early 2008 (igure 4). In early 2008, the government set the irst year of its targets
Inlation targeting in Indonesia, 1999–2012: an ex-post review
315
FIGURE 4 Key Short-Term Interest Rates, 2004–12
(% p.a.)
14
Bank Indonesia rate
12
JIBOR
10
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8
6
4
FASBI
2
0
Jan-2004
Apr-2005
Jul-2006
Oct-2007
Jan-2009
Apr-2010
Jul-2011
Oct-2012
Source: Bank Indonesia.
Note: JIBOR = Jakarta Interbank Offered Rate; FASBI = Bank Indonesia Deposit Facility, which was
inactive between April and September 2005.
at a moderately higher level and put the outer years’ targets back on their earlier
trajectory (igure 3).
In hindsight, perhaps BI ran policy too loose for too long in late 2007 and early
2008. Inlation rose from its a low point of 5.8% in June 2007 (igure 3), but BI
continued to lower the BI rate for several more months, until April 2008, by which
time inlation had climbed back to 9% – way outside the targets. Inlation received
another boost, in May 2008, from a 29% increase in domestic fuel prices (BI 2008:
5), and only then did BI begin to tighten policy. In BI’s defence, this was a period
of international instability, being the depths of the global inancial crisis, and
domestically BI was coping with early stages of the Bank Century crisis (Patunru
and Von Luebke 2010: 10–12). This episode is an excellent illustration of BI’s balancing inlation targeting with other concerns, such as output luctuations and
inancial-system stability (see ‘A wider perspective’, below). BI was correct to err
on the side of over-easing, but its actions did dilute the hard-won reputational
gains of 2005 and 2006.
There were other notable developments during this settling-in period. For
example, very little was said about targets in 2007 and 2009, although in due
course BI indicated that its targets were unchanged from the preceding year
(appendix table A1). BI continued to set policy on the basis of existing targets,
which in effect reduced the inlation-targeting time horizon from three years to
two for both 2007 and 2009.
In an unusual turn of events, both BI and the Ministry of Finance announced
targets for 2010 and beyond, but they were not exactly the same (appendix table
A1). Yet nor were they inconsistent – indeed, they were identical for 2010 (igure
5), but the outer years were potentially confusing. For example, BI’s time horizon
was ive years (to 2014) versus the Ministry of Finance’s three (to 2012). With a
Lloyd R. Kenward
316
FIGURE 5 Inlation and Oficial Upper and Lower Targets, 2009–15
(% p.a.)
10
8
12-month CPI
Government
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6
Government
4
2
0
Jan-2009
Bank Indonesia
May-2010
Sep-2011
Jan-2013
May-2014
Sep-2015
Source: Appendix table A1.
Note: The shaded bands represent the government’s implied stance on monetary policy, from easing
(light grey) to neutral (unshaded, to December 2012).
few exceptions,23 BI said little about targets between 2010 and 2014, but the difference between its end-point and that of the Ministry of Finance implied that very
little progress (only 0.5 of a percentage point) was expected during 2013–14. Also,
these differences raise questions about the quality of institutional coordination,
because the Ministry of Finance’s announcements did not refer to BI’s targets,
which had been public for months.24
Overall, 2010–12 was a period of considerable stability, underwritten in part
by rising iscal costs to subsidise fuel and electricity prices (Burke and Resosudarmo 2012: 305). Inlation slipped outside the targets on occasion, on both the
high and the low side, but only for relatively short intervals (igure 5). Relecting
this relative stability in inlation, the BI rate went unchanged for extended periods
and even showed a mild downward tendency (igure 4). Of special interest is the
surge in inlation in 2010 (igure 5), which BI (2010: 3) attributed to volatile food
prices. Noting that core inlation was steady, BI maintained a neutral policy stance
and waited for food prices to correct of their own accord.
The targets announced from 2010 to 2012 were all very much alike. Their starting points change somewhat (depending on the realised inlation rate), but the
outer-year targets are almost the same (igure 5). All of the targets provide for
only minor declines in inlation during the outer years, and none of the outer23 In June, July and August 2010, BI press releases (see ) mention a target of 4%–6% for 2010 and 2011. These press
releases pre-date the Ministry of Finance decree of 24 August 2010.
24 BI’s target is cited in the governor’s foreword to the BI’s Annual Report for 2009, dated
March 2010. The government’s announcement is dated 24 August 2010 (appendix table A1).
Inlation targeting in Indonesia, 1999–2012: an ex-post review
317
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year targets differ much from the actual inlation rates recorded between early
2011 and the end of 2012. This message was clear: Indonesia’s inlation rates were
then about as low as can be expected for the next few years. This point is pursued
towards the end of this article.
PERFORMANCE IN HITTING THE TARGETS
A central bank’s performance in inlation targeting helps determine its credibility
and thereby its inluence on inlationary expectations. One simple, quantitative
method of measuring such performance is to compare outcomes with targets.
This approach presents dificulties, to be sure, such as choosing the time horizon
and assessing inlation targeting’s contribution to some higher purpose, such as
a better economic performance overall (see Svensson 2009 and ‘A wider perspective’, below).25 This section looks more carefully at Indonesia’s inlation-targeting
performance. It begins by examining BI’s one-year-ahead record – which, as mentioned, looks too short to have any anti-inlationary effect26 – followed by BI’s
record for two and three years ahead. It then makes observations on even longer
time horizons.
Of the 11 one-year-ahead targets on record, BI hit its targets only twice, in 2007
and 2012, with one near miss, in 2002 (table 3). If we count these three years as
successes, then BI has a success rate of 27%, with misses recording an average
absolute error of 3%. Indonesia’s misses are dominated by those on the high side
of targets (six), with only three misses on the low side, which is consistent with
international experience (Roger 2009: 15) .
Extending the time horizon does not improve Indonesia’s record.27 Its performance is a little better over two years (table 4), in that the average absolute error
is markedly lower (1.8% versus 3.0%), but the authorities hit their target slightly
less frequently (25% versus 27%). A three-year time horizon sees the success rate
slip to 20% and the average absolute error jump to 4.4%.
In looking at even longer-term (four- and ive-year) targets, there is a notable
irony: BI’s targets of 6%–7% for 2002–06 and for 2003–06 would have been hit in
2006 had the authorities persisted with them (igure 1). The gains in credibility
would have been signiicant – doubly so had the authorities put those targets on
a slightly latter, downward trajectory through 2012. The outcomes for 2011 and
2012 would then have been very close to those targets, despite the inlationary
episodes of 2005 and 2008.
Another quantitative indicator of (narrowly deined) performance is the frequency with which the monthly CPI was inside the target range. During 2000–12,
25 For example, Svensson (2009) points out that as the time horizon lengthens, the likelihood increases of some change in circumstances rendering the initial policy settings
inappropriate.
26 Still, it is the time horizon against which BI reports regularly; see .
27 Assessments of two- and three-year targets were not included if the initial target was
superseded in any appreciable way by subsequent changes to the second- or third-year target. For example, the three-year target for 2005-07 was not included in table 3, because the
target for 2007 was raised by one percentage point in August 2007. See appendix table A1.
Lloyd R. Kenward
318
TABLE 3 Indonesia’s Near-Term Record in Inlation Targeting, 2000–12
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2000
2001
2002
2003
2005
2006
Error
(%)
Summary
Assessment
2.35
4.05
0.03
–3.44
10.11
–0.40
Wide miss
Very wide miss
Near miss
Very wide miss
Extremely wide miss
Miss
2007
2008
2010
2011
2012
Error
(%)
Summary
Assessment
NA
5.06
0.96
–0.21
NA
Hit
Very wide miss
Miss
Miss
Hit
Source: Author’s calculations.
Note: NA = not applicable. Error on one-year-ahead targets. Average absolute error of misses =
3.0%. Error represents actual inlation less closest edge of target range. Targets were never oficially
announced for 2004, 2009 or 2011.
actual inlation was inside Indonesia’s target range only 27% of the time, with the
bulk of misses on the high side. During 2000–05 (before the government began to
set the targets), the monthly CPI was inside the target range only 11% of the time.
This record compares unfavourably with that of Indonesia’s peers – that is,
other ‘low income’ countries, according to Roger (2009: 15)28 – owing to its success rate of 27% versus 40% and an (annual) average absolute error of 3.0% versus
2.3%.29 Grenville and Ito (2010: 49) provide data on speciic regional comparators:
Thailand (which targets core inlation with a slightly wider range than most, 3%
versus an average of about 2.5%; Hammond 2012: 9) scores an outstanding 89%,
Korea a respectable 50%–56% and the Philippines 14.5%.30
A WIDER PERSPECTIVE
This section looks at the broader picture of what has been accomplished in inlation targeting in Indonesia, because BI is not concerned solely with inlation,
notwithstanding its legal mandate and mission and vision statements. Like
every institution tasked with inlation targeting identiied by Roger (2009: 13),
BI practices ‘lexible inlation targeting’, that is, it weighs the beneits of lower
inlation against the costs of not addressing other concerns.31 For BI, these other
concerns include output luctuations (see, for example, Alamsyah et. al. 2001 and
28 These data for Indonesia begin in July 2005 (Roger 2009: 6), which implies they consider
only the government’s targets, and not those announced by BI.
29 These comparisons are slightly less unfavourable (at 33% and 2.4%, respectively) for
Indonesia when compared with low-income countries in a ‘disinlation phase’.
30 For their sample, in 2002–10, Indonesia’s inlation rate was inside its targets 13% of the
time.
31 To evaluate such a monetary-policy regime, Sevensson (2009) suggests analysing deviations between inlation gaps and output gaps, and taking into account the information
available when the policy decision was made. This would likely be a very challenging task
for Indonesia, in that detailed data would be needed on the information (and its quality)
available at BI board meetings. Grenville and Ito (2010) attempt a simpliied version of this
for Thailand, by estimating a Taylor-rule reaction function.
Inlation targeting in Indonesia, 1999–2012: an ex-post review
319
TABLE 4 Indonesia’s Medium-Term Record in Inlation Targeting, 2000–12
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Error in Two-Year-Ahead Targetsa
2002–03
2003–04
2005–06
2006–07
2007–08
2008–09
2010–11
2011–12
Error
(%)
Summary
Assessment
–3.19
–1.27
0.10
NA
5.06
–0.72
–0.21
NA
Very wide miss
Miss
Miss
Hit
Very wide miss
Miss
Miss
Hit
Error in Three-Year-Ahead Targetsb
2002–04
2003–05
2006–08
2008–10
2010–12
Error
(%)
Summary
Assessment
–1.10
9.28
5.06
1.96
NA
Miss
Extremely wide miss
Very wide miss
Miss
Hit
Source: Author’s calculations.
Note: NA = not applicable. Error represents actual inlation less closest edge of target range.
a
Absolute error of misses = 1.8%.
b
Average absolute error of misses = 4.4%.
BI 2011: xxiii); the exchange rate (as evidenced by wide swings in oficial international reserves in recent years; BI 2011: table 4.1); and inancial-system stability
(mentioned in BI’s mission statement).
It is well beyond the scope of this article to review Indonesia’s macroeconomic
policies during the past 13 years in order to isolate the contribution of monetary
policy and inlation targeting to growth and inancial stability. Nevertheless, there
is much that can be said and, in contrast with previous sections, much of it is
positive.
Downward trend in inlation while high growth sustained
The most important outcome during Indonesia’s inlation-targeting period has
been a pronounced downward trend in CPI inlation. This trend is statistically
signiicant (igure 6),32 with a coeficient that implies a decline in the rate of inlation of 0.3% annually. The results are even more striking if the trend line begins in
2001 (that is, if it excludes the unconventional, rising inlation target for 2000).33
To be sure, inlation rates of the past few years have been restrained by rising government subsidies (see ‘Important caveats’, below). Also, lower, more stable rates
of inlation have in recent years become more common across the Asia-Paciic
region (Filagro and Genberg 2010: 262), and internationally. Still, the pronounced
downward trend in Indonesia is noteworthy because it is less apparent elsewhere
(IMF 2012: igure 1.10; BI 2011: charts 1.6, 6.6).
It is equally striking that inlation has come down so far while Indonesia has
sustained strong economic growth. Since 1999, GDP growth has averaged around
32 The t-statistic on the trend coeficient is 3.7.
33 The t-statistic rises to 7.2, and the implied drop-off in inlation is almost 0.65 per annum.
Lloyd R. Kenward
320
FIGURE 6 Inlation Trends during Inlation Targeting, 2000–12
(% p.a.)
20
18
16
12-month CPI
14
12
2001–12 trend
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10
8
Linear trend
6
4
2
0
Jan-2000
Feb-2002
Mar-2004
Apr-2006
May-2008
Jun-2010
Jul-2012
Source: Bank Indonesia.
Note: CPI = consumer price index.
5.5% per annum, with slower growth in the post-crisis years, when inlation targeting was just starting. In the past six years, growth has exceeded 6% (excluding
2009, when it slipped to 4.5% during the global inancial crisis. Without doubt,
the role of inlation targeting in this result is highly uncertain, especially because
some of Indonesia’s high-growth regional comparators (China and Malaysia, for
example) have different monetary regimes. Nevertheless, it is impressive that
inlation has come down so far while strong growth has been maintained.
Other indicators of progress
Virtually all aspects of Indonesia’s inlation-targeting framework are now in line
with international ‘best practice’ (Hammond 2012; Roger 2009). These include the
target (headline inlation); the target range (two percentage points); the time horizon (three years); the authority for setting the target (the government in coordination with BI); the pursuit of lexible inlation targeting; close monitoring of the
target, especially by BI staff;34 frequent review periods (in effect, monthly); and
accountability, including communication with the public.35 The only area where
Indonesia could still be considered a fringe element concerns the mid-point of the
target. Indonesia’s relatively high mid-point target, of 4.5%, versus an average
34 BI staff consistently distinguish among core inlation (which they believe is inluenced
by monetary policy and accounts for about two-thirds of the CPI); volatile food inlation
(which, by deinition, is considered to be temporary, with a weight of about 15% in the total
CPI); and administered inlation (which is determined by governmental policy decisions,
at least on timing, with a weight of less than 20% in the CPI).
35 BI reports regularly to parliament; it publishes quarterly reports on monetary policy
and monthly reviews of monetary policy; and senior BI staff often speak with the press.
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Inlation targeting in Indonesia, 1999–2012: an ex-post review
321
of 3.3%,36 raises the question whether the government and BI should be setting
lower targets (discussed below, under ‘Sustaining progress’).
With only a few exceptions, BI’s policy decisions on interest rates have been
consistent with Indonesia’s inlation-targeting framework – and those exceptions
were necessary in the circumstances, as discussed above. BI’s response to the
increases in fuel prices in 2005, for example, was particularly effective in containing secondary inlation, and inlation targeting looks as though it proved a useful
framework for this purpose.37 BI’s response also gives conidence that Indonesia
will quickly be able to overcome future bursts in inlation stemming from large
changes in relative prices.
There have been other appropriate decisions, too. For example, broadening
the responsibility for setting inlation targets, in 2004, has added structure to the
IT process, and widened the constituency for coordination and for implementing sound policies (via, for instance, the TPI). At the time, this was not the most
common model among other countries, but the international consensus has since
shifted towards broader constituencies (igure 2).
Indonesia’s move to inlation targeting has intensiied public and private
focus on inlation in Indonesia, and the conduct of monetary policy is now more
transparent (see, for example, footnotes 13, 14, 15 and 35). Filardo and Guinigundo (2008: 33) point out that greater transparency in central-bank intentions
should reduce the dispersion of private-sector expectations and assist in the control of inlation. They ind evidence of this in reduced mode and dispersion of
local inlation forecasts among professional private-sector fo
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Inflation targeting in Indonesia, 1999–2012: an expost review
Lloyd R. Kenward
To cite this article: Lloyd R. Kenward (2013) Inflation targeting in Indonesia, 1999–2012:
an ex-post review, Bulletin of Indonesian Economic Studies, 49:3, 305-327, DOI:
10.1080/00074918.2013.850630
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Date: 17 January 2016, At: 23:48
Bulletin of Indonesian Economic Studies, Vol. 49, No. 3, 2013: 305–27
INFLATION TARGETING IN INDONESIA, 1999–2012:
AN EX-POST REVIEW
Lloyd R. Kenward*
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Victoria, Canada
Around the end of 1999, Bank Indonesia (BI) adopted inlation targeting as part
of its approach to monetary policy. This article reviews the experience up to 2012,
examines BI’s performance in hitting its inlation targets and considers certain
broader indicators of success. Overall, inlation targeting in Indonesia has been a
messy, evolutionary process, and BI’s implementation record compares unfavourably with that of its peers. Yet Indonesia recorded a signiicant downward trend in
inlation during this period and maintained strong economic growth. Also, almost
all of its inlation-targeting arrangements are now in line with common international practice. Looking ahead, this article offers suggestions for sustaining progress in inlation targeting, such as setting more ambitious targets in the outer years
and implementing strong policies to reduce inlation further, including after large
administrative price shocks.
Keywords: inlation targeting, monetary policy
INTRODUCTION
Indonesia has a well-known history of being prone to inlation (Hossain 2012:
111–17). Since independence, in 1945, the only extended period of reasonable stability was 1985–96, when the inlation rate, as measured by the consumer price
index (CPI), was generally in high single digits, averaging almost 8%.1 Against
this background, three developments in the late 1990s foreshadowed change.
First, in mid-1997 the authorities abandoned their ‘crawling band’ exchange-rate
regime, substituting the IMF- and crisis-driven model of targeting base money to
reach desired rates of nominal GDP and, in effect, inlation. Second, in May 1999
the Indonesian parliament enacted Law 23/1999 on Bank Indonesia (BI), which
deined relatively clearly the central bank’s objective2 and, in principle, granted
* The author wishes to acknowledge the many helpful comments of two anonymous
referees. Their suggestions signiicantly improved the quality of this article.
1 Source: .
2 Article 7 states that BI’s objective ‘is to achieve and maintain stability of the rupiah value’. At the time, it was unclear whether this was intended to mean low inlation or stability
in the exchange rate. BI’s mission and vision statements clearly prioritise low inlation (see
the preface to any of BI’s annual or economic reports from 2001 to 2011).
ISSN 0007-4918 print/ISSN 1472-7234 online/13/030305-23
http://dx.doi.org/10.1080/00074918.2013.850630
© 2013 Indonesia Project ANU
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306
Lloyd R. Kenward
BI suficient independence to achieve it (Alamsyah et. al. 2001), with provisions
for accountability (in chapter X of the law). And third, in 1999 BI adopted inlation
targeting, and it announced its irst targets in early 2000 (table 1).
Indonesia has had 13 years’ experience with various forms of inlation targeting, and there have been many changes during this period, including critical institutional developments (table 1). This article examines this experience, providing
international evidence and comparisons, where appropriate. It begins by reviewing developments during the inlation-targeting period to 2012, presenting BI’s
targets and outcomes in ive distinctly different sub-periods. This portion of the
article includes a discussion of BI’s policy reactions at critical times, especially
after it abandoned the growth rate of base money as its primary policy instrument, in 2005. The subsequent sections summarise BI’s record from two perspectives: the irst is a narrow, technical analysis of the authorities’ success in hitting
their targets; the second takes a broader view of BI’s accomplishments in inlation
targeting. The concluding section looks ahead and suggests ways of sustaining
Indonesia’s progress in managing inlation.
For analytical purposes, this article makes certain assumptions about oficial
inlation targets, and the weaknesses of these assumptions should be noted at
the outset. First, the analysis presents intra-year inlation targets as bands whose
end-point is deined by the target and whose starting mid-point is deined by
the actual December inlation (CPI) rate for the previous year. Oficial inlationtargeting statements and analysis are rarely explicit about intra-year targets,
although examples of this article’s approach exist in oficial documents (see, for
example, BI 2007: 84, chart 3), as do references to ‘target corridors’ (italics added).3
Second, policymakers focus mainly on their year-end forecast in relation to the
year-end target, but it is dificult to gather reliable data on the evolution of BI’s
year-end forecasts during most of this inlation-targeting period. Consequently,
this article’s comparison of CPI outcomes with the target in any given year should
be interpreted only as a reasonable proxy for BI’s assessment of ongoing developments at the time.
Nor is this article a primer on inlation targeting; it mentions the basics of the
policy only when necessary. A case in point concerns how BI responds to differences between its targets and actual inlation. BI has been relatively clear on
this subject,4 and this article inds that BI has followed its announced approach,
with only a few exceptions. For example, the decision to tighten policy (and
to what degree) depends in large part on BI’s forecast for inlation based on
unchanged policies, balanced against pressures to pursue other policy goals, such
3 See BI (2008: 120; 2009: xvii, 169; 2010: xx, xxi, xxv, 3). Table 11.9 in BI (2002: 215) presents
an indicative, linear target path for 2003–06, which is consistent with this article’s analysis.
4 Namely, ‘Any change in the monetary policy stance is undertaken after evaluating
whether future developments in inlation are on track with the established inlation target …. At the operational level, the monetary policy stance is relected in the setting of
the policy rate (BI Rate) with the expectation of inluencing money market rates and in
turn the deposit rates and lending rates in the banking system. Changes in these rates will
ultimately inluence output and inlation.’ See . See also the discussion in the text, under ‘A new beginning: 2004–06’.
Inlation targeting in Indonesia, 1999–2012: an ex-post review
307
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TABLE 1 Critical Institutional Developments in Inlation Targeting in Indonesia
May 1999
Parliament enacts Law 23/1999 on Bank Indonesia, granting the central
bank more independence to meet its objectives.
January 2000
Bank Indonesia announces its irst oficial inlation targets, for 2000.
April 2003
Law 17/2003 on State Finance requires that the government and Bank
Indonesia coordinate their monetary and iscal policies.
July 2003
The government decides to end its IMF assistance program.
January 2004
An amendment to Law 23/1999 shifts the responsibility for setting the
inlation targets to the government (with Bank Indonesia).
February 2004
Name of Bank Indonesia’s annual report changed to Economic Report on
Indonesia with release of 2003 report.
July 2004
The government and Bank Indonesia sign an MOU on the process for
setting, monitoring and controlling inlation targets.
September 2004 The Ministry of Finance issues a decree setting the government’s irst
inlation targets, for 2005–07.
July 2005
Bank Indonesia launches its new inlation-targeting framework, using
interest rates as its instrument and signal.
Note: MOU = memorandum of understanding.
as sustaining growth or maintaining inancial-sector stability.5 In addition, and as
discussed later, the instruments for tightening policy have changed over the years
and have on occasion invoked regulatory policy. Also, and most importantly for
this article, a central bank can reduce inlation with less impact on aggregate output by lowering inlationary expectations. This is a well-known and simple idea:
if a central bank is credible in its intentions to reduce inlation, disinlation is less
costly, and it is easier to hold inlation down once it is low (Blinder 2000: 1430–
1). The operative word here, however, is credible; to gain credibility in its policy
announcements, BI needs to establish a reputation for delivering its announced
policies. And herein lies the main contribution of this article: namely, a detailed
review of BI’s record in inlation targeting.
STARTING THE PROCESS: 1999–2001
BI undertook inlation targeting at a juncture of considerable uncertainty (Cameron 1999: 9–10). Inlation (as measured by the 12-month CPI) had been luctuating widely, owing to the 1997–98 Asian inancial crisis, and peaked at more than
80% in the second half of 1998. In the inal months of 1999, when decisions were
being made about the irst target within the context of Indonesia’s IMF program,
inlation was decelerating sharply, restrained by a 50% rebound in the value of the
rupiah from its low point in mid-1998 (BI 1999: chart 3.9). In recognition, in early
2000 BI put its irst target (igure 1 and appendix table A1) on a steeply rising path
and for only one year – that is, for 2000. BI was targeting core inlation at this point
(that is, inlation excluding the impact of the government’s price and income poli-
5 This is consistent with Alamsyah et. al. (2001).
Lloyd R. Kenward
308
FIGURE 1 Inlation and Bank Indonesia’s Upper and Lower Targets, 1999–2006
(% p.a.)
25
20
12-month CPI
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15
10
5
0
Jun-1999
Oct-2000
Feb-2002
Jun-2003
Oct-2004
Feb-2006
Source: Appendix table A1.
cies (BI 2000: xiv, 155)). The targets in igure 1 use headline inlation, for the sake
of comparability with the actual CPI.
Determining the desirable time horizon for inlation targeting normally
involves assessing the lag between decisions on monetary policy and their impact
on inlation.6 One year looks too short to be credible. Still, countries commonly
set one-year targets, especially when using disinlationary strategies during the
early stages of inlation targeting (Hammond 2012: 9; Roger 2009: 5), and in 1999
Indonesia was still in a disinlationary stage. But it is unconventional to announce
a steeply rising target, which does little to contain inlationary expectations, especially when actual inlation overshoots the target, as it did in 2000 (igure 1). This
combination made for an uncertain start to inlation targeting in Indonesia.
BI’s second target, for 2001, aimed at a declining rate of inlation (igure 1 and
appendix table A1). It also widened the expected range for headline inlation by
0.5 of a percentage point (appendix table A1), which was appropriate because of
ongoing volatility. Like the 2000 target, however, the 2001 target set only a oneyear time horizon. In the event, inlation rose steadily throughout 2001 (igure 1)
and inished the year well above BI’s target.
After only two years, BI’s inlation-targeting regime was at risk. To be sure, it is
not unusual for countries to have trouble achieving their inlation targets during
the early years of inlation targeting (Roger 2009: 14). But international econometric evidence (Roger 2009: 16) shows that a central bank’s missing its targets during
disinlation weakens its policy credibility. This is consistent with the Indonesian
experience; these early years set the stage for the reforms of 2004, which would
spread the responsibility more widely within the government.
6 BI research (BI 2000: 160) shows that monetary policy needs more than one year to affect
the real economy. Seasonal or cyclical factors also need time to unwind, including those
(such as Ramadan) that are not fully captured in a 12-month calculation of inlation.
Inlation targeting in Indonesia, 1999–2012: an ex-post review
309
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Commenting on this uncertain start to inlation targeting, Syahril Sabirin, the
BI governor at the time, provided some insights in his foreword to BI’s Annual
Report for 2001. To summarise, Indonesia was still reeling from the 1997–98 crisis, and the governor argued that, in such circumstances, BI could not be held
responsible for its legal mandate ‘to achieve and maintain stability of the rupiah’s
value’. Yet this researcher found no oficial answer to why BI took on a major task
such as inlation targeting at such a risky juncture.7 Perhaps it was deemed more
important to begin the process than to achieve short-term results, which would be
consistent with BI’s next steps.
A LONG-TERM PERSPECTIVE FOR A SHORT WHILE: 2001–03
Having had only limited success with one-year inlation targets, BI changed its
strategy, beginning with its targets for 2002. It moved to a more conventional, gently declining long-term target (igure 1 and appendix table A1) that incorporated
several notable features. BI changed to targeting headline inlation for the sake of
transparency and in response to changing public expectations (BI 2001: ix), which
brought Indonesia into line with international practice (Hammond 2012: 9). Also,
BI set a longer-term target,8 from 2002 to 2006 (igure 1),9 but abandoned it in 2004.
The 2006 target was only 6%–7%, which is not much lower than the 8% recorded
during the ive years of economic boom immediately before the 1997–98 crisis. BI
also narrowed the width of the target from two percentage points to one, for reasons that remain unclear. Few countries have used a target range as narrow as this
(Hammond 2012: 9), and given BI’s record for 2000 and 2001 a wider range would
have been a better choice.
Nevertheless, as 2002 unfolded, BI seemed to be making progress. Inlation
came down quickly during the irst half of the year and even fell below BI’s targets
for a short while (igure 1). By year-end, inlation was only slightly above target.
For all practical purposes, BI had scored its irst success with inlation targeting.
This success continued throughout 2003 and most of 2004 (igure 1), but questions soon arose about the exact targets. For example, BI’s economic report for
2002 states that BI stuck with its long-term perspective (of 6%–7% for 2006) but
reduced the time horizon from ive years to four years. Also, the target for the
7 The best answer was found in Goeltom (2007: 146) – namely, that a tight target speciied
for a short, one-year time horizon would help to restore BI’s credibility, provided that the
target could be achieved (italics added). In light of actual inlationary developments, Goeltom argued that BI was constrained by both supply shocks (oil and electricity prices) and
demand shocks (civil-service wage increases). This is consistent with the BI governor’s
explanation noted in the text.
8 The cautious wording is notable: ‘In the next ive years Bank Indonesia has committed
to gradually lowering the inlation rate to around 6%–7%’ (author’s translation from the
Bahasa Indonesia version, BI 2001: ix).
9 This is surprisingly long, for several reasons. First, the jump from a one- to a ive-year
time horizon is large. Second, ive years is considerably longer than the time required for
monetary policy to have an impact (generally understood to be one to two years). And,
third, few countries operate with a time horizon as long as ive years, although several
use a ‘medium-term approach’ (interpreted as two years or more) or have an ‘at all times’
perspective (Hammond 2012: 9).
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Lloyd R. Kenward
irst year was unchanged, but it was delayed by one year (from 2002 to 2003), and
the report is somewhat ambiguous about the width of the 2003 target.10 Notwithstanding its recent successes, BI was, in effect, announcing that it expected not
to accomplish much more during 2003 but to reduce inlation by another two to
three percentage points over the next three years.
Other important events were unfolding around this time, and these may have
reduced BI’s commitment to lowering inlation. For example, intense negotiations
were underway about revising Law 23/1999 on BI, and about other matters, such
as the recovery of Bank Indonesia Liquidity Assistance loans made to troubled
commercial banks during the 1997–98 crisis. BI acknowledged that these circumstances hampered its performance of its duties (BI 2003: xxi), and they eventually
erupted into a major scandal (Kong and Ramayandi 2008: 30–1). Also, national
elections were looming in the irst half of 2004, and policymakers were deferring
important decisions on fuel prices (Marks 2004: 165).
CONFUSION AND CHANGE: 2003–04
During 2003–04, Indonesia introduced many changes to its institutions and processes, apparently in search of a more effective inlation-targeting system. The
enactment of Law 17/2003 on State Finance, for example, required that the government and BI coordinate their iscal and monetary policies (Ginting 2003: 355).
And, in June 2004, elucidation 4 to the amendment to Law 23/1999 shifted the
responsibility for setting inlation targets from BI to the government.11 Inlation
targeting was now, in effect, a joint exercise.
In implementation, in May 2004 BI submitted its proposed inlation targets to
the government (BI 2004a). Also, on 1 July 2004 the government (represented by
the Minister of Finance) and the BI governor signed a memorandum of understanding (MOU) on the process for setting inlation targets and on monitoring
and control. The MOU did more than simply set the inlation targets: it established
a coordinating mechanism and deined the respective roles of the government
and BI in targeting, monitoring and controlling inlation,12 in providing public
information and building public conidence, and in promoting transparency and
10 BI (2002) ‘sets the inlation target for 2003 at 9% with a 1% error margin’ (p. 18). It is unclear whether this means 8.5%–9.5% or 8%–10%. The former looks more plausible, because
it would have been consistent with the 2006 target of 6%–7% (the target presented in igure
1). BI (2003: 53) says that the target at the beginning of 2003 was 9% with a deviation of
+/– 1%. This is strange, however, because it implies a narrowing target width from 2003 to
2006. In the event, it matters little – actual inlation remained well below both targets until
they were superseded, in September 2004 (see later in the text).
11 Neither the amendment nor the elucidation is speciic about the means that BI must
use to achieve this goal. They refer both to monetary targets and to other means, such as
open-market operations, discount rates, bank reserve requirements and credit regulations.
Elucidation 3 explicitly maintains the dichotomy (see footnote 2) that BI’s responsibility
for maintaining the rupiah’s value includes both stable prices and a stable exchange rate.
12 The MOU provides wide leeway for certain details of the targets. They can be set in terms
of headline or core CPI inlation, and they can be a range, a point or a point with deviation.
Inlation targeting in Indonesia, 1999–2012: an ex-post review
311
FIGURE 2 Authority for Setting Inlation Targets
(number of countries)
20
18
16
Bank Indonesia
Hammond’s State of the Art in Inflation Targeting
14
12
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10
8
6
4
2
0
Government
Central Bank
Both
Source: BI (2004: 19); Hammond (2012: 8).
accountability in economic policy.13 The MOU also included a commitment from
the government to adopt an inlation target before the end of July. In the event,
this did not occur until September 2004 (table 1).
Broadening institutional responsibility was a healthy step forward (mainly
because of BI’s spotty record in inlation targeting up to that point) and sought
to coordinate Indonesia’s monetary and iscal policies. It was – and, increasingly,
is – common international practice for a broader constituency to set a country’s
inlation targets (igure 2). There was also a matter of personalities. Some key individuals involved in the MOU had worked both as central bankers and in other
capacities, including as cabinet ministers. Consequently, they had a wider, crossinstitutional perspective and were, therefore, more supportive of broader institutional responsibility.
Subsequent changes to inlation targeting were determined largely by the
MOU. Following its signing, the government and BI set up the interdepartmental
Inlation Control Team (Tim Pengendalian Inlasi, TPI; BI 2004: 20; BI 2005: 85),14
which was tasked with improving coordination between BI and the Ministry of
Finance at the technical level. Its role included recommending inlation targets,
13 The Ministry of Finance Decree of 6 September 2004 included, in article 3, an explicit
provision for accountability: ‘Bank Indonesia and the government will openly explain to
parliament and the public the causes of failing to achieve the inlation target’ (author’s
translation).
14 The TPI seems to have started operating in 2005. In due course, members included BI,
the Ministry of Finance, the Coordinating Ministry for Economic Affairs, the Ministry of
Trade, the Ministry of Communications, the Ministry of Energy and Mineral Resources, the
National Development Planning Agency, the Ministry of Agriculture, and the Ministry of
Labour and Transmigration (BI 2010: 39).
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Lloyd R. Kenward
evaluating sources of potential inlationary pressure and their implications for the
targets, advising on policies for achieving the targets, and disseminating information to the public. In 2008, the TPI was expanded to include Regional Inlation
Control Teams (Tim Pengendalian Inlasi Daerah, TPIDs).15
Oficial statements about inlation targets continued to lack clarity, however,
with different targets and projections being cited at different times.16 For example,
BI’s Economic Report on Indonesia for 2003 states that ‘monetary policy in 2004 will
continue to be directed at achieving the medium-term inlation target of 6% in
2006’ (BI 2003: 17).17 Yet, in a press release, BI (2004a) indicated that monitoring
and control of inlation for 2004 would be guided by BI’s inlation projection (italics
added) for that year. This projection is deined in BI’s Economic Report on Indonesia
for 2004 as 4.5%–6.5%, where it is sometimes referred to as ‘a target’ (BI 2004: xviii,
50).18 In the event, inlation soon accelerated, reaching 6.4% in December 2004,
compared with 5.1% a year earlier.
A NEW BEGINNING: 2004–06
On 6 September 2004, the government issued its irst inlation target, for 2005–07
(igure 3). It adopted a mainstream approach to targeting headline CPI inlation
– namely, by setting a gently declining target path with a three-year time horizon, expressed as a point with a tolerance range of two percentage points, in line
with common international practice (Hammond 2012: 9). This was promising, but
within months the new approach faced its irst test, as inlation quickly moved
outside the target range (igure 3). Soaring international oil prices forced two
large increases in domestic fuel prices, in March (McLeod 2005: 140) and October
(Sen and Steer 2005: 285). BI estimated the immediate impact on the CPI at 3.75
percentage points (BI 2005: 27), and inlation came under additional near-term
pressure from the exchange rate, especially after mid-2005 (BI 2005: 59). Yet the
authorities responded well, using interest rates, supported by the aggressive use
of regulatory policy,19 to contain follow-on inlationary pressures and demonstrate their commitment to inlation targeting.
Amid this turbulence, BI took another important step in inlation targeting (BI
2004: 21). Following Indonesia’s decision in July 2003 to end its IMF program,
15 At irst, TPIDs were set up in only a few regions across Indonesia; by 2010, they were
operating in 53 regions (BI 2010: 39), apparently with the aim of covering the 66 urban areas
included in CPI calculations.
16 Given that there was no clear announcement for 2004, igure 1 does not include a formal
target for that year. Appendix table A1 notes the informal target of 5.5% +/– 1%.
17 Previously, the target for 2006 had been 6%–7% (appendix table A1).
18 There was no mention of the old 2006 target of 6%–7%. The report does refer to a 2004
target of 6%–7% for core inlation (BI 2004: 51), but this looks more like a projection than a
target. It seems coincidental that it is the same as the old target for 2006. Sarwono (2007) does
not cite an oficial 2004 target but indicates a target range of 4.5%–6.5% in one of his charts.
19 Regulatory policy reduced banks’ net open positions and strictly limited derivative
transactions (BI 2005: 70–2), mainly to protect the exchange rate. Also, the TPI was introduced (footnote 14), and there was ‘measured intervention’ in the foreign-exchange market
(BI 2005: 5).
Inlation targeting in Indonesia, 1999–2012: an ex-post review
313
FIGURE 3 Inlation and the Government’s Upper and Lower Targets, 2004–10
(% p.a.)
20
12-month CPI
15
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10
5
0
Jan-2004
May-2005
Sep-2006
Jan-2008
May-2009
Sep-2010
Source: Appendix table A1.
Note: The shaded bands represent the government’s implied stance on monetary policy (see also table
2), from tightening (dark grey) to easing (light grey) to neutral (unshaded) .
in July 2005 BI oficially moved from base money to interest rates as its operational target.20 In principle, the mechanism is simple. The so-called BI rate is set
as a ‘signal’ by BI’s board of governors,21 based on the performance of inlation
relative to the targets (BI 2005: 101). As envisaged, changes in the BI rate are then
relected quickly in the overnight interbank rate, in due course in other interest
rates (including bank lending rates), and ultimately in real activity and inlation.
Figure 4 shows the path of three key interest rates over the inlation-targeting
period.22 All have similar proiles, although the JIBOR is much more volatile during extended periods of tight (or easing) monetary policy. The broad stance of monetary policy, as indicated by the path of the rates in igure 4, is summarised in table
2 and superimposed on igures 3 and 5, to show BI’s policy responses to inlation.
The assessments in table 2 are relatively consistent with oficial BI statements, and
20 For a discussion of the considerations in choosing between base money and interest
rates, see, for example, BI (2004: 21) and Hossain (2012: chapter 7).
21 As envisaged (BI 2005: 102), the BI rate would be set quarterly (in January, April, July
and October), unless adjusted, in special circumstances, at other monthly BI board meetings. For all practical purposes, the BI rate has been set monthly.
22 The BI rate is a ‘signal’, as mentioned in the text; FASBI (Fasilitas Simpanan Bank Indonesia) is BI’s key short-term (overnight) policy rate; and JIBOR (Jakarta Interbank Overnight Rate) is a sensitive indicator of liquidity conditions in the interbank money market.
The overnight FASBI was inactive between April and September 2005, which accounts for
the gap in igure 4 (BI 2005: chapter 5). Figure 4 also uses the one-month Bank Indonesia
Certiicate (Sertiikat Bank Indonesia, SBI) rate before July 2005 (when the BI rate was introduced), in line with BI’s convention (BI 2005: chart 5.17).
Lloyd R. Kenward
314
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TABLE 2 Implied Stance of Monetary Policy
February 2004–April 2005
Neutral
Eased slightly
May 2005-April 2006
Tight
Tightened through December;
very tight through April
May 2006–December 2007
Easing
Unwound gently
January 2008–April 2008
Neutral
Perhaps eased slightly
May 2008–October 2008
Tightening
FASBI out of phase with Bank
Indonesia rate by 1 month
November 2008–August 2009
Easing
September 2009–September 2011
Neutral
Tightened in February 2011
(not signiicant)
October 2011–February 2012
Easing
Limited, compared with
previous periods
March 2012–December 2012
Neutral
Wide spread between Bank
Indonesia rate and others
Source: Author’s analysis of igure 5.
Note: FASBI = Bank Indonesia Deposit Facility.
policy adjustments tracked the CPI’s deviations quite well – especially after the
increases in fuel prices in 2005. The main exceptions, in late 2007–08 and in 2010,
when inlation surged above target, are worth emphasising at this point. In 2007–
08, BI was slow to raise interest rates, owing to concerns over the international
inancial crisis; in 2010, BI held interest rates steady, arguing – correctly – that the
surge was caused by volatile food prices, which would unwind in due course.
Much has been made of BI’s shift from base money to interest rates, including
calling it ‘fully ledged’ inlation targeting (Hossain 2012: 167; Hammond 2012:
chart 1), and contrasting it with the previous regime of ‘inlation targeting lite’
(Hossain 2012: 277). This article has a less dramatic interpretation, in part because
BI continues to refer to it, accurately, as a shift to a ‘lexible inlation targeting
framework’ (BI 2011: 81; see also ‘A wider perspective’, below). BI essentially
changed the instrument for achieving the same result, opting for the more transparent and easily understood instrument – interest rates.
Follow-up steps included setting a revised target for inlation for 2006–08,
which was announced on 17 March 2006 at a press conference called by the Economic Coordinating Minister. The new plan (appendix table A1) was to return
inlation within three years to the target envisaged before fuel prices had increased
in 2005 (igure 3). Effectively, this represented a setback of one to two years for
inlation targeting.
SETTLING IN: 2006–12
With the government’s strong policies in place, inlation came down quickly during 2006. By October that year, it had fallen below the government’s target, where
it generally stayed until mid-2007 (igure 3). As inlation fell, BI eased the BI rate
(igures 3 and 4) to a low point of 8% in late 2007, which it maintained through
early 2008 (igure 4). In early 2008, the government set the irst year of its targets
Inlation targeting in Indonesia, 1999–2012: an ex-post review
315
FIGURE 4 Key Short-Term Interest Rates, 2004–12
(% p.a.)
14
Bank Indonesia rate
12
JIBOR
10
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8
6
4
FASBI
2
0
Jan-2004
Apr-2005
Jul-2006
Oct-2007
Jan-2009
Apr-2010
Jul-2011
Oct-2012
Source: Bank Indonesia.
Note: JIBOR = Jakarta Interbank Offered Rate; FASBI = Bank Indonesia Deposit Facility, which was
inactive between April and September 2005.
at a moderately higher level and put the outer years’ targets back on their earlier
trajectory (igure 3).
In hindsight, perhaps BI ran policy too loose for too long in late 2007 and early
2008. Inlation rose from its a low point of 5.8% in June 2007 (igure 3), but BI
continued to lower the BI rate for several more months, until April 2008, by which
time inlation had climbed back to 9% – way outside the targets. Inlation received
another boost, in May 2008, from a 29% increase in domestic fuel prices (BI 2008:
5), and only then did BI begin to tighten policy. In BI’s defence, this was a period
of international instability, being the depths of the global inancial crisis, and
domestically BI was coping with early stages of the Bank Century crisis (Patunru
and Von Luebke 2010: 10–12). This episode is an excellent illustration of BI’s balancing inlation targeting with other concerns, such as output luctuations and
inancial-system stability (see ‘A wider perspective’, below). BI was correct to err
on the side of over-easing, but its actions did dilute the hard-won reputational
gains of 2005 and 2006.
There were other notable developments during this settling-in period. For
example, very little was said about targets in 2007 and 2009, although in due
course BI indicated that its targets were unchanged from the preceding year
(appendix table A1). BI continued to set policy on the basis of existing targets,
which in effect reduced the inlation-targeting time horizon from three years to
two for both 2007 and 2009.
In an unusual turn of events, both BI and the Ministry of Finance announced
targets for 2010 and beyond, but they were not exactly the same (appendix table
A1). Yet nor were they inconsistent – indeed, they were identical for 2010 (igure
5), but the outer years were potentially confusing. For example, BI’s time horizon
was ive years (to 2014) versus the Ministry of Finance’s three (to 2012). With a
Lloyd R. Kenward
316
FIGURE 5 Inlation and Oficial Upper and Lower Targets, 2009–15
(% p.a.)
10
8
12-month CPI
Government
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6
Government
4
2
0
Jan-2009
Bank Indonesia
May-2010
Sep-2011
Jan-2013
May-2014
Sep-2015
Source: Appendix table A1.
Note: The shaded bands represent the government’s implied stance on monetary policy, from easing
(light grey) to neutral (unshaded, to December 2012).
few exceptions,23 BI said little about targets between 2010 and 2014, but the difference between its end-point and that of the Ministry of Finance implied that very
little progress (only 0.5 of a percentage point) was expected during 2013–14. Also,
these differences raise questions about the quality of institutional coordination,
because the Ministry of Finance’s announcements did not refer to BI’s targets,
which had been public for months.24
Overall, 2010–12 was a period of considerable stability, underwritten in part
by rising iscal costs to subsidise fuel and electricity prices (Burke and Resosudarmo 2012: 305). Inlation slipped outside the targets on occasion, on both the
high and the low side, but only for relatively short intervals (igure 5). Relecting
this relative stability in inlation, the BI rate went unchanged for extended periods
and even showed a mild downward tendency (igure 4). Of special interest is the
surge in inlation in 2010 (igure 5), which BI (2010: 3) attributed to volatile food
prices. Noting that core inlation was steady, BI maintained a neutral policy stance
and waited for food prices to correct of their own accord.
The targets announced from 2010 to 2012 were all very much alike. Their starting points change somewhat (depending on the realised inlation rate), but the
outer-year targets are almost the same (igure 5). All of the targets provide for
only minor declines in inlation during the outer years, and none of the outer23 In June, July and August 2010, BI press releases (see ) mention a target of 4%–6% for 2010 and 2011. These press
releases pre-date the Ministry of Finance decree of 24 August 2010.
24 BI’s target is cited in the governor’s foreword to the BI’s Annual Report for 2009, dated
March 2010. The government’s announcement is dated 24 August 2010 (appendix table A1).
Inlation targeting in Indonesia, 1999–2012: an ex-post review
317
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year targets differ much from the actual inlation rates recorded between early
2011 and the end of 2012. This message was clear: Indonesia’s inlation rates were
then about as low as can be expected for the next few years. This point is pursued
towards the end of this article.
PERFORMANCE IN HITTING THE TARGETS
A central bank’s performance in inlation targeting helps determine its credibility
and thereby its inluence on inlationary expectations. One simple, quantitative
method of measuring such performance is to compare outcomes with targets.
This approach presents dificulties, to be sure, such as choosing the time horizon
and assessing inlation targeting’s contribution to some higher purpose, such as
a better economic performance overall (see Svensson 2009 and ‘A wider perspective’, below).25 This section looks more carefully at Indonesia’s inlation-targeting
performance. It begins by examining BI’s one-year-ahead record – which, as mentioned, looks too short to have any anti-inlationary effect26 – followed by BI’s
record for two and three years ahead. It then makes observations on even longer
time horizons.
Of the 11 one-year-ahead targets on record, BI hit its targets only twice, in 2007
and 2012, with one near miss, in 2002 (table 3). If we count these three years as
successes, then BI has a success rate of 27%, with misses recording an average
absolute error of 3%. Indonesia’s misses are dominated by those on the high side
of targets (six), with only three misses on the low side, which is consistent with
international experience (Roger 2009: 15) .
Extending the time horizon does not improve Indonesia’s record.27 Its performance is a little better over two years (table 4), in that the average absolute error
is markedly lower (1.8% versus 3.0%), but the authorities hit their target slightly
less frequently (25% versus 27%). A three-year time horizon sees the success rate
slip to 20% and the average absolute error jump to 4.4%.
In looking at even longer-term (four- and ive-year) targets, there is a notable
irony: BI’s targets of 6%–7% for 2002–06 and for 2003–06 would have been hit in
2006 had the authorities persisted with them (igure 1). The gains in credibility
would have been signiicant – doubly so had the authorities put those targets on
a slightly latter, downward trajectory through 2012. The outcomes for 2011 and
2012 would then have been very close to those targets, despite the inlationary
episodes of 2005 and 2008.
Another quantitative indicator of (narrowly deined) performance is the frequency with which the monthly CPI was inside the target range. During 2000–12,
25 For example, Svensson (2009) points out that as the time horizon lengthens, the likelihood increases of some change in circumstances rendering the initial policy settings
inappropriate.
26 Still, it is the time horizon against which BI reports regularly; see .
27 Assessments of two- and three-year targets were not included if the initial target was
superseded in any appreciable way by subsequent changes to the second- or third-year target. For example, the three-year target for 2005-07 was not included in table 3, because the
target for 2007 was raised by one percentage point in August 2007. See appendix table A1.
Lloyd R. Kenward
318
TABLE 3 Indonesia’s Near-Term Record in Inlation Targeting, 2000–12
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2000
2001
2002
2003
2005
2006
Error
(%)
Summary
Assessment
2.35
4.05
0.03
–3.44
10.11
–0.40
Wide miss
Very wide miss
Near miss
Very wide miss
Extremely wide miss
Miss
2007
2008
2010
2011
2012
Error
(%)
Summary
Assessment
NA
5.06
0.96
–0.21
NA
Hit
Very wide miss
Miss
Miss
Hit
Source: Author’s calculations.
Note: NA = not applicable. Error on one-year-ahead targets. Average absolute error of misses =
3.0%. Error represents actual inlation less closest edge of target range. Targets were never oficially
announced for 2004, 2009 or 2011.
actual inlation was inside Indonesia’s target range only 27% of the time, with the
bulk of misses on the high side. During 2000–05 (before the government began to
set the targets), the monthly CPI was inside the target range only 11% of the time.
This record compares unfavourably with that of Indonesia’s peers – that is,
other ‘low income’ countries, according to Roger (2009: 15)28 – owing to its success rate of 27% versus 40% and an (annual) average absolute error of 3.0% versus
2.3%.29 Grenville and Ito (2010: 49) provide data on speciic regional comparators:
Thailand (which targets core inlation with a slightly wider range than most, 3%
versus an average of about 2.5%; Hammond 2012: 9) scores an outstanding 89%,
Korea a respectable 50%–56% and the Philippines 14.5%.30
A WIDER PERSPECTIVE
This section looks at the broader picture of what has been accomplished in inlation targeting in Indonesia, because BI is not concerned solely with inlation,
notwithstanding its legal mandate and mission and vision statements. Like
every institution tasked with inlation targeting identiied by Roger (2009: 13),
BI practices ‘lexible inlation targeting’, that is, it weighs the beneits of lower
inlation against the costs of not addressing other concerns.31 For BI, these other
concerns include output luctuations (see, for example, Alamsyah et. al. 2001 and
28 These data for Indonesia begin in July 2005 (Roger 2009: 6), which implies they consider
only the government’s targets, and not those announced by BI.
29 These comparisons are slightly less unfavourable (at 33% and 2.4%, respectively) for
Indonesia when compared with low-income countries in a ‘disinlation phase’.
30 For their sample, in 2002–10, Indonesia’s inlation rate was inside its targets 13% of the
time.
31 To evaluate such a monetary-policy regime, Sevensson (2009) suggests analysing deviations between inlation gaps and output gaps, and taking into account the information
available when the policy decision was made. This would likely be a very challenging task
for Indonesia, in that detailed data would be needed on the information (and its quality)
available at BI board meetings. Grenville and Ito (2010) attempt a simpliied version of this
for Thailand, by estimating a Taylor-rule reaction function.
Inlation targeting in Indonesia, 1999–2012: an ex-post review
319
TABLE 4 Indonesia’s Medium-Term Record in Inlation Targeting, 2000–12
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Error in Two-Year-Ahead Targetsa
2002–03
2003–04
2005–06
2006–07
2007–08
2008–09
2010–11
2011–12
Error
(%)
Summary
Assessment
–3.19
–1.27
0.10
NA
5.06
–0.72
–0.21
NA
Very wide miss
Miss
Miss
Hit
Very wide miss
Miss
Miss
Hit
Error in Three-Year-Ahead Targetsb
2002–04
2003–05
2006–08
2008–10
2010–12
Error
(%)
Summary
Assessment
–1.10
9.28
5.06
1.96
NA
Miss
Extremely wide miss
Very wide miss
Miss
Hit
Source: Author’s calculations.
Note: NA = not applicable. Error represents actual inlation less closest edge of target range.
a
Absolute error of misses = 1.8%.
b
Average absolute error of misses = 4.4%.
BI 2011: xxiii); the exchange rate (as evidenced by wide swings in oficial international reserves in recent years; BI 2011: table 4.1); and inancial-system stability
(mentioned in BI’s mission statement).
It is well beyond the scope of this article to review Indonesia’s macroeconomic
policies during the past 13 years in order to isolate the contribution of monetary
policy and inlation targeting to growth and inancial stability. Nevertheless, there
is much that can be said and, in contrast with previous sections, much of it is
positive.
Downward trend in inlation while high growth sustained
The most important outcome during Indonesia’s inlation-targeting period has
been a pronounced downward trend in CPI inlation. This trend is statistically
signiicant (igure 6),32 with a coeficient that implies a decline in the rate of inlation of 0.3% annually. The results are even more striking if the trend line begins in
2001 (that is, if it excludes the unconventional, rising inlation target for 2000).33
To be sure, inlation rates of the past few years have been restrained by rising government subsidies (see ‘Important caveats’, below). Also, lower, more stable rates
of inlation have in recent years become more common across the Asia-Paciic
region (Filagro and Genberg 2010: 262), and internationally. Still, the pronounced
downward trend in Indonesia is noteworthy because it is less apparent elsewhere
(IMF 2012: igure 1.10; BI 2011: charts 1.6, 6.6).
It is equally striking that inlation has come down so far while Indonesia has
sustained strong economic growth. Since 1999, GDP growth has averaged around
32 The t-statistic on the trend coeficient is 3.7.
33 The t-statistic rises to 7.2, and the implied drop-off in inlation is almost 0.65 per annum.
Lloyd R. Kenward
320
FIGURE 6 Inlation Trends during Inlation Targeting, 2000–12
(% p.a.)
20
18
16
12-month CPI
14
12
2001–12 trend
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10
8
Linear trend
6
4
2
0
Jan-2000
Feb-2002
Mar-2004
Apr-2006
May-2008
Jun-2010
Jul-2012
Source: Bank Indonesia.
Note: CPI = consumer price index.
5.5% per annum, with slower growth in the post-crisis years, when inlation targeting was just starting. In the past six years, growth has exceeded 6% (excluding
2009, when it slipped to 4.5% during the global inancial crisis. Without doubt,
the role of inlation targeting in this result is highly uncertain, especially because
some of Indonesia’s high-growth regional comparators (China and Malaysia, for
example) have different monetary regimes. Nevertheless, it is impressive that
inlation has come down so far while strong growth has been maintained.
Other indicators of progress
Virtually all aspects of Indonesia’s inlation-targeting framework are now in line
with international ‘best practice’ (Hammond 2012; Roger 2009). These include the
target (headline inlation); the target range (two percentage points); the time horizon (three years); the authority for setting the target (the government in coordination with BI); the pursuit of lexible inlation targeting; close monitoring of the
target, especially by BI staff;34 frequent review periods (in effect, monthly); and
accountability, including communication with the public.35 The only area where
Indonesia could still be considered a fringe element concerns the mid-point of the
target. Indonesia’s relatively high mid-point target, of 4.5%, versus an average
34 BI staff consistently distinguish among core inlation (which they believe is inluenced
by monetary policy and accounts for about two-thirds of the CPI); volatile food inlation
(which, by deinition, is considered to be temporary, with a weight of about 15% in the total
CPI); and administered inlation (which is determined by governmental policy decisions,
at least on timing, with a weight of less than 20% in the CPI).
35 BI reports regularly to parliament; it publishes quarterly reports on monetary policy
and monthly reviews of monetary policy; and senior BI staff often speak with the press.
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Inlation targeting in Indonesia, 1999–2012: an ex-post review
321
of 3.3%,36 raises the question whether the government and BI should be setting
lower targets (discussed below, under ‘Sustaining progress’).
With only a few exceptions, BI’s policy decisions on interest rates have been
consistent with Indonesia’s inlation-targeting framework – and those exceptions
were necessary in the circumstances, as discussed above. BI’s response to the
increases in fuel prices in 2005, for example, was particularly effective in containing secondary inlation, and inlation targeting looks as though it proved a useful
framework for this purpose.37 BI’s response also gives conidence that Indonesia
will quickly be able to overcome future bursts in inlation stemming from large
changes in relative prices.
There have been other appropriate decisions, too. For example, broadening
the responsibility for setting inlation targets, in 2004, has added structure to the
IT process, and widened the constituency for coordination and for implementing sound policies (via, for instance, the TPI). At the time, this was not the most
common model among other countries, but the international consensus has since
shifted towards broader constituencies (igure 2).
Indonesia’s move to inlation targeting has intensiied public and private
focus on inlation in Indonesia, and the conduct of monetary policy is now more
transparent (see, for example, footnotes 13, 14, 15 and 35). Filardo and Guinigundo (2008: 33) point out that greater transparency in central-bank intentions
should reduce the dispersion of private-sector expectations and assist in the control of inlation. They ind evidence of this in reduced mode and dispersion of
local inlation forecasts among professional private-sector fo