Small scale macroeconomic model of Indonesia

Abstract

This thesis aims to capture the structure of the Indonesian economy through the construction and simulation of a small scale macroeconomic model (SSMM). It is timely to devise an SSMM for Indonesia as it is currently moving towards an inflation targeting regime. We carry out dynamic and stochastic simulations of the model to investigate the effects of an increase in external demand; to understand the role of credibility of the central bank in inflation targeting; and to experiment with different policy rules in the Indonesian SSMM. We found that the credibility of the central bank is crucial for achieving the inflation target. We also found that both Taylor and money supply rules perform equally well in describing the trade-off between inflation and output volatilities in the Indonesian economy. Finally, we found that including an exchange rate argument in the policy rule helps monetary policymakers reduce fluctuations in inflation and output.