MONETARY POLICY AND FINANCIAL CONDITIONS IN INDONESIA
We develop a financial condition index (FCI) and examine the effects of monetary
policy on financial conditions in Indonesia. We show that our FCI tracks financial
conditions quite well because it captures key financial events (the Asian financial
crisis of 1997–1998, the Indonesian banking crisis, and the global financial crisis and
its aftermath). A unique feature of our FCI is that it is quarterly and thus offers near
real-time development in financial conditions. We also show that monetary policy
shapes the FCI. A contractionary monetary policy leads to unfavourable financial
conditions during the first two quarters, followed by favourable financial conditions
for nearly three quarters. This finding is robust to an alternative identification strategy.
Our findings highlight the critical role of the monetary authority in shaping financial
conditions in Indonesia.
Stability in a Dynamic Global Environment: Bank Indonesia’s Policy
Perspectives (October 2016). BIS Paper No. 88f. Available at SSRN: https://ssrn.
Bernanke, B. S. (1986). Alternative Explanations of the Money–Income Correlation.
In: Brunner, K., & Meltzer, A. (Eds.), Real Business Cycles, Real Exchange
Rates, and Actual Policies. Carnegie-Rochester Conference Series on Public Policy,
vol. 25. North-Holland, Amsterdam.
Blanchard, O., & Watson, M. (1986). Are All Business Cycles Alike? In: Gordon,
R.J. (Ed.), The American Business Cycle. University of Chicago Press, Chicago,
Blanchard, O. J., & Quah, D. (1989). The Dynamic Effects of Aggregate Demand
and Supply Shocks. American Economic Review, 79, 655–673.
Brave, S., & Butters, R. (2011). Monitoring Financial Stability: A Financial
Conditions Index Approach. Economic Perspectives, 35, 22–43.
Canova, F. (2007). Methods for Applied Macroeconomic Research. Princeton, NJ:
Princeton University Press.
Christiano, L., Eichenbaum, M., & Evans, C. (1999). Monetary Policy Shocks:
What Have I Learned and to What End? In: Woodford, M., Taylor, J.B. (Eds.),
Handbook of Macroeconomics. North-Holland, Amsterdam, 65–148.
Cushman, D. O., & Zha, T. (1997). Identifying Monetary Policy in a Small Open
Economy Under Flexible Exchange Rates. Journal of Monetary Economics, 39,
Debuque-Gonzales, M., & Gochoco-Bautista, M. S. (2017). Financial Conditions
Indexes and Monetary Policy in Asia. Asian Economic Papers, 16, 83-117.
Dudley, W., & Hatzius, J. (2000). The Goldman Sachs Financial Conditions Index:
The Right Tool for a New Monetary Policy Regime. Global Economics Paper No.
Freedman, C. (1994). The Use of Indicators and of the Monetary Conditions Index
in Canada. Frameworks for monetary stability: policy issues and country experiences,
Gauthier, C., Graham, C., & Liu, Y. (2004). Financial Conditions Indexes for
Canada. Bank of Canada Working Paper No. 2004–22.
Geweke, J. (1977). The Dynamic Factor Analysis of Economic Time Series Models. In
Latent Variables in Socioeconomic Models, ed. D. J. Aigner & A. S. Goldberger,
365–383. Amsterdam: North-Holland.
Goldstein, M. (1998). The Asian Financial Crisis: Causes, Cures, and Systemic
Implications. Peterson Institute, 55.
Goodhart, C., & Hofmann, B. (2001). Asset Prices, Financial Conditions, and The
Transmission of Monetary Policy. In conference on Asset Prices, Exchange Rates,
and Monetary Policy (March, 2001), Stanford University (2-3).
Guichard, S., & Turner, D. (2008). Quantifying the Effect of Financial Conditions
on US Activity. OECD Economics Department Working Paper No. 635.
Guichard, S., Haugh, D., & Turner, D. (2009). Quantifying the Effect of Financial
Conditions in the Euro Area, Japan, United Kingdom, and United States.
OECD Economics Department Working Paper No. 677.
Iyke, B.N. (2018a) A Test of the Foreign Exchange Market Efficiency in Indonesia.
Bulletin of Monetary Economics and Banking (forthcoming).
Iyke, B. N. (2018b). Assessing the Effects of Housing Market Shocks on Output:
The Case of South Africa. Studies in Economics and Finance, 35, 287-306.
Juhro, S. M., & Goeltom, M. (2013) The Monetary Policy Regime in Indonesia
(November 1, 2013). Macro-Financial Linkages in Pacific Region, Akira Kohsaka
(Ed.), Routledge, February 2015. Available at SSRN: https://ssrn.com/
Koop, G., & Korobilis, D. (2014). A New Index of Financial Conditions. European
Economic Review, 71, 101-116.
Mayes, D., & Virén, M. (2001). Financial Conditions Indexes. Bank of Finland
Discussion Paper No. 2001–17.
Rubio-Ramírez, J., Waggoner, D., & Zha, T. (2010). Structural Vector Autoregressions:
Theory of Identification and Algorithms for Inference. Review of Economic
Studies, 77, 665-696.
Satria, D., & Juhro, S. M. (2011). Risk Behavior in the Transmission Mechanism of
Monetary Policy in Indonesia. Bulletin of Monetary Economics and Banking, 13,
Sargent, T. J., & Sims,C. A. (1977). Business Cycle Modeling without Pretending
to Have too much a Priori Economic Theory. In New Methods in Business Cycle
Research: Proceedings from a Conference, ed. C. A. Sims, 45–109. Minneapolis:
Federal Reserve Bank of Minneapolis.
Shinkai, J.-I., & Kohsaka, A. (2010). Financial Linkages and Business Cycles of
Japan: An Analysis Using Financial Conditions Index. OSIPP Discussion Paper
No. 2010-E-008. Osaka School of International Public Policy.
Sims, C. A. (1986). Are Forecasting Models Usable for Policy Analysis. Minneapolis
Federal Reserve Bank Quarterly Review Winter, 2–16.
Sims, C. A. (1992). Interpreting the Macroeconomic Time Series Facts. European
Economic Review, 36, 975–1011.
Stock, J. H., & Watson, M. W. (1991). A Probability Model of the Coincident
Economic Indicators. In Leading Economic Indicators: New Approaches and
Forecasting Records, ed. K. Lahiri and G. H. Moore, 63–89. Cambridge:
Cambridge University Press.
Swiston, A. (2008). A U.S. Financial Conditions Index: Putting Credit where Credit
is Due. IMF Working Paper No. 08/161.
Osorio, M. C., Unsal, D. F., & Pongsaparn, M. R. (2011). A Quantitative Assessment
of Financial Conditions in Asia (No. 11-170). International Monetary Fund.
Perron, P., & Vogelsang, T. J. (1992). Nonstationarity and Level Shifts with an
Application to Purchasing Power Parity. Journal of Business & Economic
Statistics, 10, 301-320.
Uhlig, H. (2005). What are the Effects of Monetary Policy on Output? Results from
an Agnostic Identification Procedure. Journal of Monetary Economics, 52, 381-
Yamazawa, I. (1998). The Asian Economic Crisis and Japan. The Developing
Economies, 36, 332-351.
Copyright (c) 2019 Buletin Ekonomi Moneter dan Perbankan
This work is licensed under a Creative Commons Attribution-NonCommercial 4.0 International License.
Buletin Ekonomi Moneter dan Perbankan / Bulletin of Monetary Economics and Banking is licensed under a Creative Commons Attribution-NonCommercial 4.0 International License.