Inflation expectations formation and financial stability in Indonesia

Ishak-Kasim, Syurkani and Ahmed, Abdullahi D. (2009): Inflation expectations formation and financial stability in Indonesia. Published in: The Empirical Economic Letters , Vol. 8, No. 9 (September 2009): pp. 833-842.

Abstract

This paper examines the role of expectations in explaining the dynamics of inflation, interest rates and other key financial variables in Indonesia using VAR and error correction analyses. It is found that deposit interest rates, exchange rates and oil prices have significant impact on the expectations formation. We also found that administered prices are important, but their role decreases with time, while exogenous shocks remain a major source of movements in the expectations. The latter has long lasting effects and still accounts for more than 10 per cent of the variability of inflation expectations after the period of one year. This evidence shows the importance of inflation expectations formation, particularly on domestic financial stability.

• Item Type: MPRA Paper
• Language: English
• Keywords: Inflation expectations; Formation; Financial Stability; Indonesia
• Subjects: E - Macroeconomics and Monetary Economics > E4 - Money and Interest Rates > E42 - Monetary Systems ; Standards ; Regimes ; Government and the Monetary System ; Payment Systems; E - Macroeconomics and Monetary Economics > E3 - Prices, Business Fluctuations, and Cycles > E31 - Price Level ; Inflation ; Deflation; E - Macroeconomics and Monetary Economics > E5 - Monetary Policy, Central Banking, and the Supply of Money and Credit > E58 - Central Banks and Their Policies; G - Financial Economics > G2 - Financial Institutions and Services > G28 - Government Policy and Regulation; E - Macroeconomics and Monetary Economics > E6 - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook > E61 - Policy Objectives ; Policy Designs and Consistency ; Policy Coordination

References

uncertainty in the Euro zone: Evidence from survey data. Review of World Economics,144 (2), 325-346.

Bank Indonesia, 2003, Economic report on Indonesia. Jakarta: Bank Indonesia.

Bank Indonesia, 2006, Economic report on Indonesia. Jakarta: Bank Indonesia.

Choy, K. M., Leong, K., and Tay, A. S., 2006, Non-fundamental expectations and economic fluctuations: Evidence from professional forecasts. Journal of Macroeconomics, 28 (2), 446-460.

Dahl, C. M., and Hansen, N. L., 2001, The Formation of inflation expectations under changing inflation regimes. Studies in Nonlinear Dynamics and Econometrics, 4(4), 183- 212.

De Carvalho, F. A., and Bugarin, M. S., 2006, Inflation expectations in Latin America. Economia, 6 (2), 101-145.

Hamilton, J. D., 1994, Time series analysis. Princeton, New Jersey: Princeton University Press.

Harris, R., and Sollis, R., 2003, Applied times series modelling and forecasting. Chichester, England: John Wiley & Sons Ltd.

Johansen, S., 1991, Estimation and hypothesis testing of cointegration vectors in Gaussian vector autoregressive models. Econometrica, 59( 6), 1551-1580

Jolliffe, I. T., 1986. Principal component analysis. New York: Springer-Verlag New York Inc.

Lance, C. E., Butts, M. M., and Michels, L. C., 2006,. The sources of four commonly reported cutoff criteria: What did they really say? Organizational Research Methods, 9 (2), 202-220.

Majardi, F., 2004, Analisis empiris mengenai dinamika pembentukan harga dan upah [Empirical analysis on price and wage dynamics], Bank Indonesia Research Notes (December 2004). Jakarta: Bank Indonesia.

Mehra, Y. P., and Herrington, C., 2008,. On the sources of movements in inflation expectations: A few insights from a VAR model. Economic Quarterly (Federal Reserve Bank of Richmond), 9 4(2), 121-146.

Osborn, D. R., 1990, A survey of seasonality in UK macroeconomic variables. International Journal of Forecasting, 6 (3), 327-336.

Sargent, T. J., Williams, N., and Zha, T. A., 2006, The conquest of South American inflation, Working Paper 2006-20. Atlanta: Federal Reserve Bank of Atlanta.

Smith, L. I., 2002, A tutorial on Principal Components Analysis. Dunedin, NZ: University of Otago.

Tyziak, T., and Stanislawska, E., 2006,. Consumer inflation expectations: Survey questions and quantification methods – the case of Poland, NBP Working Papers No. 37. Warsaw: the National Bank of Poland.