A study of Indonesia's external adjustments using monetary approach 1969-1990
Date
1992-01
Authors
Journal Title
Journal ISSN
Volume Title
Publisher
Abstract
The study aims to: 1) test whether the monetary approach explains the external adjustments behavior of Indonesia from 1969 to 1990, 2) prove by empirical means whether the monetary approach is relevant and advantageous to Indonesia, and 3) provide empirical support to the monetary approach vis-a-vis other approaches to external adjustments.
The methodology involves testing first the two assumptions of the monetary model, namely, the price and interest rate arbitrage (unified goods market and unified bond market) and the existence of a stable money demand function. Having these assumptions held, the estimation of Indonesia's external adjustments (fluctuation in the balance of payments in 1969- 1978 and fluctuation in the exchange rate in 1978- 1990) was estimated using the monetary model developed for this purpose. The estimation procedures used included the ordinary least squares, two-stage least squares, and the Cochrane-Orcutt transformations.
The results of the estimation confirmed that in the case of Indonesia's balance of payments, there is a one-to-one substitution of domestic asset for foreign asset, giving support to the hypothesis that the balance of payments is a monetary phenomenon. Estimation of fluctuation in Exchange rate suggest that the actual behavior of exchange rate in the period 1978 - 1990 is highly consistent with prediction of the monetary model.
Fluctuation in exchange rate of Indonesia are largely explained by such variables as domestic money demand, domestic income and expected inflation, consistent with the hypothesis of the monetary approach.
The study, therefore, provides empirical evidence to the relevance and usefulness of the monetary approach to account changes in the balance of payments and the exchange rate in Indonesia.