Toward Improved Monetary Policy in Indonesia

Indonesia’s depreciation vastly exceeded that of all other countries hit by
the Asian crisis. It also experienced far higher inflation. This paper argues that there is
a close medium- to long-term relationship between money growth and inflation in
Indonesia, and that this has not been greatly disturbed by the crisis. It argues that
Indonesia’s disappointing performance in relation to maintaining the value of the
rupiah can be explained by the central bank’s failure to sterilise the monetary impact
on base money of its last resort lending to the banks. The fundamental lesson is that
Bank Indonesia would be well advised to adopt slow and steady growth of base
money as the nominal anchor for monetary policy, now that the pre-crisis policy of
slow and steady depreciation of the rupiah has been abandoned.