The Role of the Central Bank in Promoting Sustainable Growth: Perspectives on the Implementation of Flexible ITF in Indonesia

Abstract

The global financial crisis of 2008-09 (GFC) and the deep accompanying recession created an overarching structural condition of a global and domestic demand shortage. Since then, from a broader policy perspective, there has been a growing call for a revival of the subdued role of the central bank in promoting sustainable economic growth. This paper shows that, in the midst of global uncertainty, the policy configuration to maintain sustainable economic growth should be aimed to simultaneously strike the internal and external balance. Th is implies that domestic policy cannot abandon export promotion strategies, while building up the domestic demand side of the economy. The role of the central bank, therefore, should be directed to integrate monetary and financial system stability frameworks. The paper also shows that the post-GFC monetary policy framework enhancement in Indonesia is characterized by the Flexible Infl ation Targeting Framework (ITF). In this regard, the policy framework continues to adhere to an infl ation target as the overriding objective of monetary policy. Th e main characteristics of ITF will remain; however, Bank Indonesia must also consider a number of other factors, including financial sector stability as well as the dynamics of capital fl ows and exchange rates. Th e feasibility of the framework should be in line with the empirical fi ndings of this paper and provide a firm justifi cation that, in a broader sense, a monetary policy framework aimed at achieving price stability is relevant for the Indonesian economy. By adopting ITF-based monetary policy, Bank Indonesia has sufficient policy space to absorb a certain degree of negative impacts of a crisis, thus preserving economic growth. To this point, strengthening policy coordination between Bank Indonesia and the Government in order to advance structural reform is sufficient to drive sustainable growth in the medium–long term.

Keywords

• Monetary policy, Instrument mix, Infl ation Targeting Framework (ITF), Flexible ITF, Bank Indonesia

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