Indonesia : Changing Patterns of Financial Intermediation and Their Implications for Central Bank Policy

As a bank-based economy, global factors affect financial intermediation and monetary transmission in Indonesia mainly through financial markets. Foreign portfolio flows to Indonesia are mostly in the form of government bonds and corporate equities, and thus directly influence the movements of the exchange rate, bond yields and equity prices. Liquidity from these portfolio flows also affect interest rate setting and bank lending. Problems in the monetary transmission mechanism arise from the shallowness of domestic financial markets, often causing excessive volatility of financial asset prices in times of stress. As such, a monetary policy that relied solely on interest rates would not be effective. We find that a policy mix of interest rates complemented by flexible exchange rate and macroprudential measures directed toward mitigating excessive lending in certain sectors and external vulnerabilities is more effective in achieving monetary and financial stability.Full publication: "http://ssrn.com/abstract=2692232" What Do New Forms of Finance Mean for EM Central Banks?