Central Bank Policy: Theory and Practice

✍ Scribed by Perry Warjiyo and Solikin M. Juhro

• Publisher: Emerald Publishing
• Year: 2019
• Tongue: English
• Leaves: 586
• Category: Library

✦ Synopsis

Central Bank Policy: Theory and Practice analyses policies and practices adopted by central banks globally, as well as the institutional arrangements underlying the principles of good governance in policymaking. Discussion focuses on philosophical and conceptual theories that have key implications for central bank policy making and findings are supported by relevant quantitative analyses and case studies reflecting recent issues with respect to centralized financial policy making, including the adoption of the Inflation Targeting Framework in Indonesia. The book bridges the gap between theory and practice within the central bank policy framework by going beyond the rapidity of theoretical developments to address lesser known and understood policy practices, such as the Flexible Inflation Targeting Framework and macroprudential policy. With wide ranging scope and in-depth materials presented, alongside the authors' extensive experiences and involvement in the policymaking process at Bank Indonesia, Central Bank Policy is a vital practical tool and reference aid for policymakers, practitioners and academic researchers in the area of financial, banking, and monetary policies.

✦ Table of Contents

Contents
List of Figures
List of Tables
About the Authors
Preface
Part I: General Review
Chapter 1: Introduction
1.1. The Central Bank and Economy
1.2. Central Bank, Academic Thinking, and Political Economy
1.3. Objectives of the Book
1.4. Systematics of the Writing
1.5. Utility of the Book
Chapter 2: Central Bank Evolution and Reform
2.1. Introduction
2.2. The Evolving Role of the Central Bank
2.2.1. Gold Standard Era and Real Bills Doctrine: 1840–1930
2.2.2. Central Banks under Government Control: 1940–1970
2.2.3. Central Bank Independence and Inflation Targeting: 1980–2007
2.2.4. Central Banks and the Global Financial Crisis of 2008/2009
2.3. Central Bank Policy Reform
2.3.1. Monetary Policy, Price Stability, and Exchange Rates
2.3.2. Exchange Rate Stability and Foreign Capital Flows
2.3.3. Monetary and Financial System Stability
2.3.4. Payment Systemic Stability
2.4. Central Bank Institutional Reform
2.4.1. Credibility, Independence, and Accountability
2.4.2. Transparency and Communication
2.4.3. Institutional Arrangements and Coordination
2.5. Concluding Remarks
Part II: Monetary Policy and Economy
Chapter 3: The Role of Money and Monetary Policy in the Economy
3.1. Introduction
3.2. Theoretical Review
3.2.1. The Role of Money in the General Equilibrium Analysis
3.2.2. Relationship between Money−Output and Imperfect Information
3.2.3. The Money−Output Correlation against Imperfect Market Competition and Price Rigidity
3.2.4. The Role of Money in the Monetarist Analysis Framework: “Money Matters” and the Keynesian-Neoclassical Synthesis
3.3. Empirical Evidence and Related Issues
3.3.1. Monetary Policy Modeling and Variable Selection Issues
3.3.2. Consensus Regarding the Role of Money and Monetary Policy
3.3.3. Empirical Evidence in Indonesia
3.4. Market Imperfections and the New Paradigm of Monetary Economics: Credit Matters
3.4.1. Credit Availability and Bank Behavior: Credit Rationing Equilibrium
3.4.2. A New Paradigm in Monetary Economics Theory
3.5. Concluding Remarks
Chapter 4: Exchange Rates and the Economy
4.1. Introduction
4.2. Exchange Rate Determination Theory
4.2.1. Mundell–Fleming Model: Policy Trilemma
4.2.2. Exchange Rate Model with Sticky Prices: Dornbusch’s Overshooting Model
4.2.3. Portfolio Balance Model and Central Bank Monetary Operations
4.2.4. Market Microstructure Models: Order Flows and Heterogeneous Information
4.3. Empirical Findings for Exchange Rates and the Economy
4.3.1. Exchange Rates and Trade
4.3.2. Exchange Rate and Inflation
4.3.3. Empirical Findings in Indonesia
4.4. Exchange Rate System and Policy
4.4.1. Choice of Exchange Rate System: Theoretical Review
4.4.2. Exchange Rate Systems in Practice: Bipolarization and Fear of Floating
4.4.3. Exchange Rate Crises: Causes and Impacts
4.4.4. Exchange Rate Stabilization Policy: Foreign Exchange Intervention
4.4.5. Exchange Rate System and Policy in Indonesia
4.5. Concluding Remarks
Chapter 5: Monetary Policy Transmission Mechanism
5.1. Introduction
5.2. Monetary Policy and the Transmission Mechanisms
5.2.1. MPTM Map
5.2.2. The Importance of Monetary Policy Transmission
5.2.3. Policy Rate and Monetary Operations
5.2.3.1. Interest Rate Policy. The interest rate policy adopted by the central bank will influence short-term interest rates on the interbank money market as well as market expectations of macroeconomic projections and the future direction of the central
5.2.3.2. Monetary Operations. The central bank performs monetary operations to influence liquidity conditions and, therefore, interest rates on the interbank money market in line with the policy rate set. To that end, the central bank projects bank liquid
5.2.3.2. Foreign Exchange Intervention. Exchange rate stability is very important for the economy, especially in EME and developing countries, therefore many central banks, including BI, pay a lot of attention to MPTM through the exchange rate channel. In
5.3. Monetary Transmission Channels: The Money View
5.3.1. Interest Rate Channel
5.3.2. Asset Price Channel
5.3.3. Exchange Rate Channel
5.3.4. Expectations Channel
5.4. Monetary Transmission Channels: The Credit View
5.4.1. Bank Lending and Bank Capital Channels
5.4.1.1. Bank Lending Channel. The first model of the bank lending channel was developed by Stiglitz and Weiss (1981) based on the assumption that the borrower has access to private information about the feasibility of his/her businesses. Despite producin
5.4.1.2. Bank Capital Channel. Bank capital also affects credit supply. Van den Heuvel (2002) studied the impact of the CAR and ability of banks to issue shares. Bank capital could be influenced by the ability to generate profit, the market price assessme
5.4.2. Balance Sheet Channel
5.4.2.1. External Finance Premium. The ideas of Bernanke, Gertler, and Gilchrist (1999) as well as Clastorm and Fuerst (2000) represent two salient references in the external finance premium model. For each business transaction, there is always the possib
5.4.2.2. Collateral Constraints. Financial accelerators can be analyzed using the collateral for loan transactions between lender and borrower. The seminal views of Kiyotaki and Moore (1997) represent an important reference in the analysis based on diffic
5.4.3. Risk-taking Channel
5.4.3.1. Risk-taking Dynamics. Financial theory in terms of investment teaches return optimization in line with the levels of risk of each respective alternative investment. This is achieved through risk diversification by forming an optimal investment po
5.4.3.2. The Role of Liquidity. Financial amplification through the risk-taking channel is also inextricably linked to liquidity, as an important element of financial transactions. There are two types of liquidity, namely funding (cash) liquidity and mark
5.5. Monetary Policy Transmission in Various Countries
5.5.1. Monetary Policy Transmission in Advanced Countries
5.5.1.1. Monetary Policy Transmission in the EU. Unification of the euro currency had an immediate impact on monetary policy transmission, with the loss of the exchange rate channel between countries in the EU. The economic and monetary union led to a uni
5.5.1.2. Monetary Policy Transmission in the United States. Bernanke and Blinder (1992) were among the first to apply a VAR model to map monetary policy transmission channels in the United States, revealing three important findings. First, the federal fun
5.5.2. Monetary Policy Transmission in EMEs
5.5.2.1. Interest Rate Channel, Asset Price Channel, Exchange Rate Channel, and Expectations Channel. A study by Moreno (2008) showed that, in many EME, the effect of the policy rate on deposit and lending rates is generally stronger and more persistent t
5.5.2.2. Credit and Balance Sheet Channels. Dominant banking sectors in many EME mean that the credit channel plays an important role in terms of influencing investment. The degree of influence varies, however, namely that it is stronger in Latin America
5.5.2.3. Monetary Policy Transmission in the Post-GFC Era. The GFC precipitated an important MPTM evolution in EMEs due to three salient factors, namely the relative role of banks on the bond market, money market globalization, and low long-term interest
5.5.3. Monetary Policy Transmission in Indonesia
5.5.3.1. Interest Rate, Exchange Rate, Asset Price, and Expectations Channels. A study by Kusmiarso et al. (2002) documented the growing role of the interest rate transmission channel in Indonesia. Specifically, using a money market structural model, the
5.5.3.2. Bank Lending and Balance Sheet Channels. Previous research provided complete empirical evidence concerning the bank lending channel in Indonesia (Agung, Morena, Pramono, and Prastowo, 2002a, 2002b). Three methods were used in the study. First, a
5.5.3.3. Transmission of Risk-taking Behavior and the Central Bank Policy Mix. Research performed by Satria and Juhro (2011) was the first empirical study concerning the impact of risk-taking behavior on lending by banks in Indonesia. The econometric mode
5.6. Concluding Remarks
Part III: Monetary Policy Framework
Chapter 6: Monetary Policy Strategic Framework
6.1. Introduction
6.2. Conceptual Dimension and Theoretical Models
6.2.1. Final Policy Target: Output Versus Prices
6.2.1.1. Targeting Long-term Policy Goals. Theoretically, the benefits of the respective policy strategies could be observed from the perspective of implementing monetary policy in the near term and long term. In this case, the characteristics of the econ
6.2.1.2. Targeting Short-term Policy Goals. In the near term, the monetary policy target selected, be it price stability or output stability, will be affected by shocks in the economy, irrespective of demand-side or supply-side sources. A simple analysis
6.2.2. Monetary Policy Regime
6.2.2.1. Exchange Rate Targeting. There are three alternative approaches to exchange rate targeting as a monetary policy strategy. First, by pegging the value of the domestic currency to certain commodities recognized internationally, such as gold (known
6.2.2.2. Monetary Targeting. In many countries, exchange rate targeting is not the primary choice of monetary policy strategy because of the requirements mentioned above, including monetary policy restrictions or flexibility to meet the domestic economic
6.2.2.3. Inflation Targeting. As the relationship between monetary aggregates and the final target of monetary policy faded, many countries began to adopt inflation targeting, which is implemented by publishing the medium-term inflation target and committ
6.2.2.4. No Explicit Anchor Targeting. Seeking to achieve the desired economic performance, monetary policy strategy can be implemented without an explicit anchor but still paying attention and providing commitment to achieve the final target of monetary
6.2.2.5. Nominal Income Targeting. Fundamentally, targeting nominal (output) income is based on the view that monetary policy can only affect nominal income growth rather than its determinants in the form of inflation and real output growth. In addition,
6.3. Empirical Studies and Related Issues
6.3.1. Short-term Output-prices Trade-off and the Phillips Curve Phenomenon
6.3.1.1. Presence of the Phillips Curve. The first issue relating to the emergence of empirical facts is stagflation, namely low economic growth coupled with high inflation, as experienced by industrialized nations in the 1970s, who opposed the trade-off
6.3.1.2. Linearity in the Phillips Curve. The second issue is based on the findings of Laxton, Meredith, and Rose (1995) concerning the asymmetric effect of economic activity on inflation in seven major OECD countries. The study provided an important conc
6.3.1.3. Formation of Expectations in the Phillips Curve. During development in the 1990s, studies of the Phillips curve tended to focus more on the effect of forming rational expectations on the trade-off between inflation and output per the Neo-Keynesia
6.3.2. Output-prices Trade-off in the Economic Cycle
6.3.3. Sacrifice Ratio: Cost of Controlling Inflation
6.4. Implementation in Several Jurisdictions
6.4.1. Final Target of Monetary Policy
6.4.1.1. A Shift in Priorities from the 1970s to 1980s. Economic dynamics around the world in the 1970s were characterized by the desire to stimulate economic growth and create job opportunities, consistent with the goal of economic development at that ti
6.4.1.2. From the 1990s Until the Present Day. Since the 1990s to the present day, nearly all central banks around the world have adopted price stability as the final target of monetary policy. In fact, most central banks have formally applied a monetary
6.4.2. Monetary Policy Regime
6.4.2.1. Exchange Rate Targeting. The exchange rate targeting regime was introduced by several countries as part of the efforts to control inflation during the 1980s. With the inherent advantages of the regime, exchange rate targeting successfully lowered
6.4.2.2. Monetary Targeting. Two countries that have seriously and successfully implemented monetary targeting are Germany and Switzerland. The success of such a policy on controlling inflation in those two countries is the reason why monetary targeting c
6.4.2.3. Inflation Targeting. As the relationship between monetary aggregates and the final policy target faded, inflation targeting emerged as a new monetary policy framework that appealed to countries previously plagued by inflation control problems in
6.4.2.4. No Explicit Anchor Targeting (Implicit Targeting). Fundamentally, several countries have practiced this strategy, evidenced by impressive macroeconomic performance (including low and stable inflation) without resorting to a nominal anchor, such a
6.5. The Monetary Policy Regime in Indonesia (1968–1998)
6.5.1. Economic Stabilization and Rehabilitation (1968–1972)
6.5.2. Era of Oil-based Economic Growth (1973–1982)
6.5.3. Period of Economic Deregulation, Debureaucratization, and Liberalization (1983–1997)
6.6. Concluding Remarks
Chapter 7: Monetary Policy Operational Framework
7.1. Introduction
7.2. Conceptual Dimension and Theoretical Models
7.2.1. Policy Instruments: Money Supply Versus Interest Rate
7.2.1.1. Standard Poole Model with Demand-side Shocks. Analyzing the ­conditions where each respective instrument is appropriate, Poole applied a simple Keynesian approach for goods market (investment savings (IS)) and money market (liquidity preference m
7.2.1.2. Poole Model Variations with Supply-side Shocks and the Role of ­Market Expectations. Fundamentally, the standard Poole model only calculated demand-side shocks (from the IS–LM equation). Poole model variations, however, also take into considerati
7.2.2. Policy Response: Rules Versus Discretion
7.2.2.1. Feedback Rule and Optimal Monetary Policy. Through development to the present day and consistent with money demand function instability (money multiplier), the use of constant rules, standard or soft, has started to fade, replaced by feedback rul
7.2.2.2. Simple Feedback Rule. One monetary rule, in the form of a simple feedback rule, is the monetary growth rule or McCallum rule. Where monetary growth reflects the policy response to the average change in base velocity, as a correction to the ongoin
7.2.3. Several Aspects of Optimal Monetary Policy Formulation
7.3 Application in Several Countries
7.3.1. Operational Targets and Monetary Policy Instruments
7.3.1.1. Operational Target: Monetary Aggregates Versus Interest Rates. In practice, the central bank may choose alternative operational targets, including short-term interest rates, monetary aggregates, and exchange rates. Departing from trends in advanc
7.3.1.2. Monetary Control Instruments. In terms of the monetary policy instruments used, in practice, there are two types of instruments employed by central banks around the world, namely direct and indirect market-based instruments. The choice of policy
7.3.2. Monetary Policy Response: Policy Rules
7.3.2.1. Implicit Interest Rate Policy Rule in Several Countries. A study by Clarida et al. (2000) provided a complete analysis framework for monetary policy implementation in the United States during the period from 1990 to 1996. The backward-looking Ta
7.3.2.2. Role of Monetary Aggregates When Applying an Implicit Rule. ­Congruent with the shift in the preferred operational target from monetary aggregates (money base) to short-term interest rates, particularly in advanced countries, use of the interest
7.4. Monetary Operations in Indonesia
7.4.1. Quantity-based Approach
7.4.2. The Shift from the Quantity-based Approach to the Price-based Approach
7.5. Concluding Remarks
Chapter 8: Inflation Targeting Framework: Concept and Implementation at Central Banks
8.1. Introduction
8.2. Conceptual Dimension and Theoretical Model
8.2.1.1. Rationale. Fundamentally, ITF is a framework where monetary policy can be directed toward achieving a future inflation target that is published transparently as a tangible form of central bank commitment and accountability. This definition contai
8.2.1.2. Characteristics. The rationale detailed above underlies the ITF-based monetary policy framework. In this regard, ITF is a monetary policy framework with a number of salient characteristics, namely an official statement from the central bank that
8.2.1.3. Advantages and Disadvantages. The growing number of countries applying ITF demonstrates that the framework offers several advantages over monetary policy regimes using money supply, the exchange rate or other anchors (Bernanke et al., 1999; Leide
8.2.2. Theoretical Model
8.2.2.1. Baseline ITF Macroeconomic Model. Consensus from both sides, New Keynesian and New Neoclassical Synthesis, has produced a viewpoint concerning the substance of ITF theory, namely that “inflation dynamics depend on expected (future) inflation and
8.2.2.2. ITF in the Inflation Forecast Targeting Format. According to Svensson (1997), in line with the forward-looking policy perspective, the substance of ITF could connote inflation forecast targeting. This has implications on the specification of the
8.3. Institutional and Operational Framework
8.3.1. Institutional Framework
8.3.1.1. Central Banking Laws. ITF implementation requires regulations in central bank laws stipulating price stability as the target of monetary policy and providing full authority to the central bank to achieve that target (instrument independence). In
8.3.1.2. Formulation of the Inflation Target. Formulation of the inflation target also varies among ITF countries in terms of the price index used, size of the target, target horizon, and publication method. Inflation target formulation primarily depends
8.3.1.3. Accountability and Transparency. All central banks applying ITF operate transparently because public accountability is an integral element of successful monetary policy. The importance of the accountability mechanism is clear because of the lag b
8.3.2. Operational Framework
8.3.2.1. Inflation Projections. In ITF, inflation projections play a key role in terms of monetary policy formulation, primarily considering the lag between monetary policy and its impact on inflation. Therefore, the ability to predict inflation will dete
8.3.2.2. Policy Transmission. As elucidated in the previous chapter, deep understanding of the monetary policy transmission mechanism is an integral element of implementing monetary policy. Such understanding becomes even more important in ITF because it
8.3.2.3. Policy Implementation. The operational target of monetary policy normally used by ITF central banks are short-term interest rates, usually overnight to 1 month. In addition to closely reflecting the actions of the central bank, short-term interes
8.4. Inflation Targeting Regimes
8.4.1. Regime and Rationale
8.4.2. Clarity of Commitment to the Inflation Target
8.4.3. Inflation Targeting Regime Credibility
8.4.4. Inflation Targeting Regime Classification
8.4.5. The Importance of Regime Classification
8.5. Inflation Targeting and Economic Performance
8.5.1.1. Inflation Targeting Successes. Mishkin and Schmidt-Hebbel (2001) are perhaps the best reference to draw several success stories during the first decade of ITF implementation in the 1990s from various previous empirical studies. Nevertheless, it i
8.5.1.2. Alternative Opinions. The conclusions made by Mishkin and Schmidt-Hebbel (2001) generally reflect the views of economists as well as central bankers applying ITF. The ITF success stories underlie the economists’ volition to propose ITF as the ide
8.5.2. Inflation Targeting after the GFC of 2008/2009
8.6. Concluding Remarks
Chapter 9: Inflation Targeting Framework: Implementation in Indonesia
9.1. Introduction
9.2. Institutional Framework
9.2.1. BI Act
9.2.2. Inflation Target Formulation
9.2.3. Accountability and Transparency
9.3. Operational Framework
9.3.1. Inflation Projection Techniques
9.3.2. Monetary Policy Transmission
9.3.3. Monetary Operations
9.4. Evolution Thus Far
9.4.1. Issues during the ITF Transition Period
9.4.2. An Evaluation of ITF Implementation since July 1, 2005
9.5. Strengthening the ITF Implementation Strategy after the Global Financial Crisis
9.6. Concluding Remarks
Part IV: Institutional Aspect of Central Bank Policy
Chapter 10: Monetary Policy Credibility and Time Consistency
10.1. Introduction
10.2. Conceptual Dimension of Policy Credibility
10.2.1 Causes of the Credibility Problem
10.2.2. Effort to Improve Credibility
10.3. Theoretical Model Concerning the Policy Credibility Problem: Time Inconsistency
10.3.1. Kydland and Prescott’s Model
10.3.2. Barro-Gordon Model
10.3.3. Credibility Problem Analysis with Supply Shocks
10.4. Empirical Studies: Measures of Credibility and Time Inconsistency
10.4.1. Parameterization Approach: Credibility Index
10.4.2. Qualitative Approach (Narrative)
10.4.3. Quantitative Modeling Approach
10.5. Assessing Monetary Policy Credibility in Indonesia
10.5.1. Policy Credibility in Indonesia during ITF Implementation
10.5.2. Empirical Studies of Time Inconsistency in Indonesia
10.6. Concluding Remarks
Chapter 11: Central Bank Independence and Accountability
11.1. Introduction
11.2. Conceptual and Empirical Dimensions of Independence and Accountability
11.2.1.1. Goal Independence. Fundamentally, the goal of monetary policy can be defined in broad terms, not only as the choice between price stability and output, but also the target horizon, the concrete indicators used, the value of the target and the es
11.2.1.2. Instrument Independence. Instrument independence implies that the central bank sets its own operational targets without government intervention. According to Bofinger (2001), independence has three important control elements as follows: (1) cont
11.2.1.3. Personal Independence. Despite enjoying goal independence and/or instrument independence, a central bank may struggle to achieve personal independence because the government could exert informal pressures on monetary policy implementation. For e
11.2.2. Central Bank Accountability
11.2.3. Correlation between Independence and Accountability
11.3. Theoretical Models Concerning Independence and Accountability
11.3.1. Delegation of Authority Theory: Conservative Agent
11.3.2. Central Bank Accountability Theory: Democratic Accountability
11.4. Empirical Studies and Related Issues
11.4.1. Central Bank Independence and Economic Performance
11.4.2. Related Issues
11.4.2.1. The Critical Issue of Central Bank Independence: Two Fallacies. There are at least two conclusions fundamental to the spectrum of studies on central bank independence, including the works of Rogoff (1985), Persson and Tabellini (1993), Alesina a
11.4.2.2. Ex Post and Ex Ante Accountability: The Difference between Accountability and Transparency. From the perspective of policy implementation timing, central bank accountability can fundamentally be debated in two forms, namely ex post and ex ante a
11.4.3. Policy Independence and Credibility during a Crisis Period
11.5. Bank Indonesia’s Independence and Accountability
11.5.1. Bank Indonesia’s Independence
11.5.2. Bank Indonesia’s Accountability
11.6. Concluding Remarks
Chapter 12: Policy Transparency and Communication Strategy
12.1. Introduction
12.2. Conceptual Dimension of Policy Transparency and Communication Strategies
12.2.1. Several Viewpoints Concerning Transparency
12.2.1.1. Scope of Transparency: Full Versus Limited. From an economic perspective, the main argument supporting the need for full transparency is that monetary policy would be most effective if correctly anticipated by the markets. That argument is base
12.2.2. Transparency, Monetary Policy Regime, and Democratic Accountability
12.2.2.1. Transparency and Democratic Accountability. The trend of democratization that has affected many countries, particularly in the past decade, has increased calls for transparent public policies, including monetary policy. The central bank is a pub
12.2.3. Monetary Policy Communication Strategy
12.2.3.1. Scope of Communication. The principle underlying monetary policy transparency is that the information communicated helps the public to understand, and anticipate, the central bank’s decisions as a logical conclusion to the policy sequence orient
12.2.3.2. Communications Methods. Sundarajan et al. (2003) proposed four basic dimensions that determine the credibility of policy transparency, namely: (1) the means or media used; (2) timeliness; (3) periodicity; and (4) the quality and scope of the inf
12.2.3.3. Communication Targets. To whom monetary policy transparency and communication is targeted is a reflection of the democratic accountability principles described previously. Blinder et al. (2003) suggested four main targets of central bank communi
12.3. Theoretical Models on Policy Transparency: Conservative Central Bank and Imperfect Transparency
12.3.1. Political Transparency: Public Uncertainty concerning the Preferred Weight of Output Stabilization (Parameter b)
12.3.2. Economic Transparency: Public Uncertainty to Changes in Economic Factors (value of parameter k)
12.3.3. Implications of Imperfect Transparency
12.4. Practices and Empirical Studies of Transparency and Communication Strategies in Different Countries
12.4.1. Assessing Transparency by the IMF
12.4.2. Practices at Several Prominent Central Banks
12.4.3. Monetary Policy Transparency and Economic Performance
12.4.3.1. Methodology. In their study, Chortareas et al. (2002) focused on the publication of economic forecasts by the central bank and its impact on inflation and output volatility. The hypothesis constructed from the nascent theories developing in the
12.4.4. Transparency and the Communication Strategy in a Crisis Period
12.5. Transparency and the Communication Strategy in Indonesia
12.5.2. Bank Indonesia’s Communication Strategy
12.6. Concluding Remarks
Chapter 13: Monetary Policy and Foreign Capital Flows
13.1. Introduction
13.2. Theoretical Dimension and Foreign Capital Flow Developments
13.2.1. Neoclassical Theory and PI Theory
13.2.2. Determinants of Foreign Capital Flows: Push and Pull Factors
13.3. Foreign Capital Flows and Economic Performance
13.3.1. Empirical Phenomenon: “Lucas Paradox”
13.3.2. Important Takeaways from the Lucas Paradox
13.3.2.1. Economic Fundamentals. The production and institutional structures in a particular country could create disparity between investment returns and the measures of marginal productivity of capital and labor. Several factors play an important role i
13.3.2.2. Domestic Financial Sector Deepening. The domestic financial sector plays a vital role in mobilizing savings and stimulating foreign capital flow intermediation efficiently for productive financing of economic growth. One neoclassical assumption
13.3.2.3. Imperfect International Finance. Imperfect international finance creates deviation between the actual and desired capital returns, thus engendering distortions between foreign capital flows, investment, and economic growth. Obstfeld and Rogoff (
13.4. Foreign Capital Flows and Monetary Stability
13.4.1. Empirical Studies on the Effect of Capital Flow Volatility
13.4.2. Monetary Policy Trilemma in an Open Economy
13.4.3. Foreign Capital Flows and Monetary Policy Dynamics in Indonesia
13.5. Foreign Capital Flow Management: Theories and Practices
13.5.1. Principles, Targets, and Instruments
13.5.1.1. Formulation and Implementation Principles. In general, the following conditions serve as a reference for when foreign CFM is applicable (IMF, 2012). First, foreign CFM is required when the space to make further macroeconomic policy adjustments b
13.5.1.2. Targets: Macroeconomic Stability and/or Financial System Stability. Foreign CFM requires a clear target, whether it be macroeconomic stability, financial system stability or both. The answer will depend upon the types and volatility of the capi
13.5.1.3. Instrument Selection: Prudential Regulations or Capital Controls. Which instruments are available to mitigate the risks associated with foreign capital flows? In general, the policy options depend on the conditions specific to the country invol
13.5.2. Foreign CFM Practices
13.5.2.1. Foreign CFM Effectiveness: Brazil and Colombia. Brazil and Colombia apply foreign CFM to mitigate the undesired impact on competitiveness and monetary policy autonomy (Ostry et al., 2011). In 2007, Colombia imposed unremunerated reserve requirem
13.5.2.2. Macroprudential Regulations on Capital Flows: South Korea. In South Korea, exporters – particularly shipbuilding companies with scheduled dollar receipts – were required to hedge against future export proceeds. Such exporters wished to sell thei
13.5.2.3. Prudential Regulations on Foreign Loans: Croatia. Foreign banks have dominated the Croatian banking system since the year 2000 and have played an important role in terms of foreign capital flows to the country. A sure of capital flows prompted i
13.6. Concluding Remarks
Chapter 14: Macroprudential Policy and Financial System Stability
14.1. Introduction
14.2. Conceptual Dimension of FSS
14.2.1. The GFC of 2008 / 2009 and FSS
14.2.2. Central Bank’s Role in FSS
14.2.3. Central Bank Macroprudential Policy
14.3. Theoretical Model and Empirical Evidence of Financial Procyclicality
14.3.1. Financial Accelerator Theory
14.3.2. Empirical Evidence for Financial Procyclicality
14.3.2.1. Asset Price Bubbles. Hunter, Kaufman, and Pomerleano (2003) and Evanoff, Kaufman, and Malliaris (2012) conducted literature reviews covering various aspects of asset price bubbles and the implications on monetary policy, regulation, and internat
14.3.2.2. Credit Booms and Busts. The importance of credit as an indicator to understand the financial cycle and its impact on a crisis was also emphasized by Schularick and Taylor (2012). Using data covering 140 years from 14 advanced countries for the p
14.3.2.3. Procyclical Capital Flows. Numerous studies have demonstrated procyclical capital flows. Kaminsky, Reinhart, and Vegh (2004), for instance, studied capital flow procyclicality and the interaction with fiscal and monetary policy. Using data from
14.4. Theoretical Model and Empirical Evidence for Interconnectedness and Financial Networks
14.4.1. Theory of Interconnectedness and Financial Networks
14.4.2. Empirical Evidence for Financial Interconnectedness
14.5. Macroprudential Policy Theory and Practices
14.5.1. Principles, Targets, and Instruments
14.5.2. Application in Various Jurisdictions
14.6. Concluding Remarks
Chapter 15: Central Bank Policy Mix
15.1. Introduction
15.2. Conceptual Dimension of the Central Bank Policy Mix
15.2.1. Integration of the Price Stability and Financial System Stability Targets
15.2.2. Basic Concepts of the Central Bank Policy Mix
15.2.3. Central Bank Policy Mix Transmission Mechanism
15.3. Structural Macroeconomic Modeling: Integrated Inflation Targeting
15.3.1. From Flexible to Integrated Inflation Targeting
15.3.2. Model Structure and Analysis Framework
15.3.3. Central Bank Policy Mix Formulation
15.4. DSGE Modeling with Macrofinancial Linkages
15.4.1. Macrofinancial Modeling Approaches in DGSE
15.4.2. Monetary Policy and Macroprudential Policy in DSGE Modeling
15.4.3. Central Bank Policy Mix Formulation
15.5. Bank Indonesia Policy Mix
15.5.1. Policy Mix Targets and Instruments
15.5.2. Interest Rate and Exchange Rate Policies
15.5.3. Foreign Capital Flow Management
15.5.4. Macroprudential Policy
15.5.5. Institutional Arrangements
15.6. Concluding Remarks
Bibliography
Index