Managing Monetary and Financial Stability in a Dynamic Global Environment : Bank Indonesia's Policy Perspectives

As the Indonesian economy is becoming progressively more integrated with the global economy, the impact of global economic shocks on the domestic economy is becoming more pronounced. Capital inflows, which trigger excessive liquidity and exacerbate the risk of a sudden reversal, pose a serious threat to the Indonesian economy, especially in terms of financial stability. Recent crisis episodes have indicated that monetary policy alone is insufficient to maintain macroeconomic stability; it should be accompanied by macroprudential policy. This paper explores the dynamics of the external and financial sectors as well as the optimal policy mix in order to maintain monetary and financial stability. We use an enhanced or modified small open-economy New Keynesian model to discuss the operation of a flexible inflation targeting framework (ITF). The simulations show that the model's impulse response functions are in line with theoretical and empirical predictions, in which external shocks have significant impacts on both monetary and financial stability. The simulations also show that the adverse macroeconomic and financial effects of external shocks can be mitigated by a mix of monetary and macroprudential policies.Full Publication: 'http://ssrn.com/abstract=2861007' Expanding the Boundaries of Monetary Policy in Asia and the Pacific