monetary policy in indonesia program mm stie perbanas
TRANSCRIPT
Monetary Policy in Indonesia
Program MMSTIE Perbanas
Scope of discussion
• How the monetary sector affects the economy?• Demand and supply of money• Transmission of monetary policy• Monetary policy in the long-run • Policy conflicts• Money Supply Process• Framework of monetary policy• Monetary Operations
EXTERNAL SECTOR
Current AccountExportImport
TransferIncome
Capital & Financial Transaction
Direct Investment Financial flows
– Government– Private
Official foreign reserves
REAL SECTOR
Consumption Investment Export Import
GOVERNMENT SECTOR
Fiscal (APBN)Revenues, incl. grantExpenditures Primary balances Financing – Domestic – External Luar Negeri
MONETARY SECTOR
Monetary Authority Foreign assets net Domestic assets net Net Claim on Government
Commercial Banks Foreign assets net Domestic assets net
Base money
Money supply
How the monetary sector affects the economy? (Interrelationship among macroeconomic accounts)
Aggregate demand:Y = C + I + G + (X-M)
Supply and Demand for Money
• Supply of money : Ms = mm * Mo – determined by the central bank.
• Demand for money : Md = f (GDP, CPI)– determined by people or money holder
Definition of money: Mo = C + Rb where Mo = monetary base (high-powered money) ; C = Currency (bank notes);
Rb = Bank reserves (banks’ account at the central bank + cash in vault)
M1 = C + DD where DD = Demand deposits (checking accounts, giro accounts)
M2 = C + DD + TD where TD = Saving and Time deposits
M3 = M2 +
Supply and Demand for Money - Equilibrium
• Supply of money is determined by the central bank monetary policy, and therefore the supply curve is vertical.
• Demand for money is inversely related to the money rate of interest, because higher interest rates make it more costly to hold money instead of interest-earning assets like bonds.
• Equilibrium: The money interest will gravitate the rate where the quantity of money people want to hold (demand) is just equal to the stock of money the central bank has supplied (supply).
Quantityof Money
Interest rate Ms
Md
Qs
i*
At i*, people are willing to hold the money supply set by the central bank
Excesssupply
Excessdemand
i2
i3
Transmission of monetary policy • The path that monetary policy takes through the macroeconomic system is called the
Transmission of Monetary Policy.
• The impact of a shift in monetary policy is generally transmitted through intrest rates, exchange rates, and assets prices.
• An expansionary monetary policy will increase supply of loanable funds and put downward pressure on real interes rates. As real interest rates falls, aggregate demand increases (to AD2), leading to a short run increase in output (Y1 to Y2…..and prices (from P1 to P2)… inflation
Goods/services(real GDP)
Price level
AS1
AD1
Y1 Y2
P1AD2
P2
Quantity of Loanable funds
RealInterest rate
Q
r2 D
S1 S2
Monetary policy in the long-run• If the impact of an increase in AD accompanying expansionary policy is felt when the economy
operating below capacity, the policy will help direct the economy back to a long-run full employment output equilibrium (Yf).
• In contrast, if the demand-stimulus effects are imposed on an economy already at full employment (Yf), they will lead to excess demand, higher prices,and temporarily higher output (Y2).
• In the long-run, the strong demand will push up resources prices, shifting back short-run AS.
• The price level rises to P3 (from P2) and output back to Yf once again.
Goods/services(real GDP)
Price level
SRAS1
AD1
Yf Y2
P1
AD2P2
Goods/services (real GDP)
PriceLevel
Y1
P2
AD1
SRAS1
LRAS
AD2P1
Yf
e1
e2
SRAS2
LRAS
P3
e1
e2
e3
Direct monetary transmission 8
Money
MonetaryPolicy:
Base moneyInterest rate
Final Objective:
PricesOutput
Interest rate channel
Real interest
Cost of capital
Substitution effect
Income effect
Asset price channel
Exchange rateNet exports-cap.flows
Tobin’s q
Wealth effect
Credit channels
Bank lending Loan Supply-Demand
Ext. Financing, LeverageFirms balance sheet
Imported prices
Equity-Property prices
Expectation channel
Expectation Real interest rate
Moral hazard,Adverse selection
Uncertainty
Money Supply-Demand
The Mechanism of monetary transmission
Policy conflicts
• Theoretically, in the short-term there is trade-off between achieving targets of containing inflation and promoting output– Phillips Curve: = (y – y*) – Long-run full employment vs below capacity
• However, there is growing research evidence that maximum employment, sustainable economic growth, and price stability can be compatible with one another in the longer run.
• Expantionary monetary policy leads to promote economic activities, but would in turn push inflation upward A need to strike a balance between monetary and fiscal policy and other macroeconomic policies policy coordination.
Monetary policy in the long-run
• The quantity theory of money– M * V = P * Y where M = money; V = velocity of money;
P = price; Y = income– If V and Y are constant, than an increase in M would lead to a
proportional increase in P.
• Implication:– In the long run, the primary impact of monetary policy will be on prices
rather than on real output– When expansionary monetary policy leads to rising prices, monetary
authorities eventually anticipate the higher inflation and build it into their choices
– As it happens, nominal interest rates, wages, and incomes will reflect the expectation of inflation, and so real interest rates, wages, and output will return to their long-run normal levels.
Player in the money supply process:• Central bank (Bank Indonesia)
• Banks (depository institutions)
• Depositors (individuals and institutions)
Money Suppy Process
Banking System Bank Indonesia’s Balance Sheet
Assets Liabilities Assets Liabilities
Reserves Deposits Government Securities
Currency in circulation
Government securities
Borrowings Banks’ giro/ reserves
SBIs SBIs
Shifts from Deposits into Currency
Nonbank Public Banking System
Assets Liabilities Assets Liabilities
Checkable deposits
- 100 Reserves - 100 Checkable deposits
- 100
Currency + 100
Bank Indonesia
Assets Liabilities
Currency in circulation
+ 100
Reserves -100
Net effect on monetary liabilities is zero
Deposit Creation: Single Bank
Excess reserves increase
Bank loans out the excess reserves
Creates a checking account
Borrower makes purchases
The money supply has increased
Bank BCA Bank BCA
Assets Liabilities Assets Liabilities
Securities -100 Securities -100 Checkable deposits
+100
Reserves +100 Reserves +100
Loans +100
Bank BCA
Assets Liabilities
Securities -100
Loans +100
Deposit Creation: The Banking System
Bank A Bank A
Assets Liabilities Assets Liabilities
Reserves 100 Checkable deposits
100 Reserves 10 Checkable deposits
+100
Loans +90
Bank B Bank B
Assets Liabilities Assets Liabilities
Reserves +90 Checkable deposits
+90 Reserves +9 Checkable deposits
+90
Loans +81
Creation of Deposits (assuming 10% reserve requirement and a Rp 100 increase in reserves)
Bank Increase in Deposits (Rp)
Increase in Loans (Rp)
Increase in reserves (Rp)
Bank BCA 0.00 100.00 0.00
A 100.00 90.00 10.00
B 90.00 81.00 9.00
C 81.00 72.90 8.10
D 72.90 65.61 7.29
E 65.61 59.05 6.56
F 59.05 53.14 5.91
Total for all banks 1000.00 1000.00 100.00
The Formula for Multiple Deposit Creation
Assuming banks do not hold excess reserves
Required Reserves ( ) = Total Reserves ( )
= Required Reserve Ratio ( ) times the total amount
of checkable deposits ( )
Substituting
=
Dividing both s
RR R
RR r
D
r D Rides by
1 =
Taking the change in both sides yields
1 =
r
D Rr
D Rr
Factors that Determine the Money Supply
• Changes in the required reserves ratio
– The money supply is negatively related to the required reserve ratio.
• Changes in currency holdings
– The money supply is negatively related to currency holdings.
• Changes in excess reserves
– The money supply is negatively related to the amount of excess reserves.
M m MB
The Money Multiplier
• Define money as currency plus checkable deposits: M1
• Link the money supply (M) to the monetary base (MB) and let m be the money multiplier
• Ms = mm x Mo --- mm = Ms/Mo – mm¹ = M1/Mo (narrow money multiplier)
– mm² = M2/Mo (broad money multiplier)
• Assume that the desired holdings of currency C and excess reserves ER grow proportionally with checkable deposits D, then
c = {C/D} = currency ratio
e = {ER/D} = excess reserves ratio
Money Multiplier
• The total amount of reserves ( R ) = required reserves (RR) + excess reserve( ER)
• RR = required reserve ratio (r ) x third party deposits (D)
• R = (r x D ) + ER
• Bank Indonesia sets r = 5%
• The monetary base MB equals currency (C) plus reserves (R):MB = C + R = C + (r x D) + ER
• Equation reveals the amount of the monetary base needed to support the existing amounts of third party deposits, currency and excess reserves.
Money Multiplier
c = {C / D} C = c D and
e = {ER / D} ER = e D
Substituting in the previous equation
MB (r D) (eD) (c D) (r e c)D
Divide both sides by the term in parentheses
D 1
r e cMB
M D C and C c D
M D (c D) (1 c)D
Substituting again
M 1 c
r e cMB
The money multiplier is then
m 1 c
r e c
Reserve requirement
• In the most countries, all depository financial institutions are required to conform to the deposit reserve requirements set by the central bank.
• Changes in reserve requirements are a very potent, though little-used tool.
• Indeed, reserve requirements have recently been reduced in the U.S., and eliminated in Canada, New Zealand, and the U.K.
• An increase in deposit reserve requirements decreases the deposit and money multipliers, slowing the growth
of money, deposits and loans reduces the amount of excess legal reserves - institutions
deficient in required legal reserves will have to sell securities, cut back on loans, or borrow reserves
increases interest rates, particularly in the money market, as depository institutions scramble to cover any reserve deficiencies
Instruments Operational target
Intermediatetarget
Ultimate target
Framework of monetary policy in Indonesia
Operational target Strategic target
Nominal“Anchor”
- Exchange rate - Monetary variables - Inflation (inflation targeting)- Nominal output - No explicit nominal anchor
Targets
- OMO - Interest rates (ST) - Interest rates (LT) - Inflation - Reserve requirement - Base money - M1, M2, kredit (since Act # 23/1999) - Discount window - Interest rates - Moral suasion (BI rate)
Inflation Targeting “A Framework, Not A Rule”
Monetary operations
Policyresponse
Policy Indicators
Ultimate target
Inflationtarget
• Public welfare• Trade off between
inflation & output Inflasi dan Output
• Expectation
Output growth
Inflationforecast
BI RateMonetary
instruments
• Factors affecting inflation
• Linkage among macroecon variables
• Monetary trasmission moneter
PolicyCredibility
• Liquidity management
• Interest rates corridor
• Interest rate sstructure
• Exchange rate stability
• Other monetary and banking objectives
Coordination with Government
Policy communication• Commitment/Consistency• Building expectation
+
+
Model, research, stat, expert opinion, judgement
Transmission mechanism of monetary operations
Indicators :- M1, M2- Bank’s Loan
Indicators :- Import Price IndexIndicative Targets:
- Bank reservesIndicators:- Surveys- Leadings- Output Gap
Indicators :- CPI- Underlying Core- Asset Price- Other Price•Adm/Non•Trade/Non•Food/Non
OMO
DiscountWindow
RR
FXIntervention
SBIAuction
FASBI
Money Market
Liquidity
InterestRate
AssetPrice
Expectation &Confidence
ExchangeRate
DomesticSupply
DomesticDemand
DomesticInflation
Pressures
Indicators:- Money Market Rates- Deposit Rates- Lending Rates- IHSG- Exchange Rates
ForeignInflation
Pressures
Moral Suasion
Monetary transmission through pricing approach
Official Rate
(BI rate)
Domestic demand
Net external demand
Market interest rates
Asset prices
Expectations/confidence
Exchange rate
Total demand
DomesticInflationary
pressure
Inflation
Importprices
Monetary operations
How open market operations change monetary conditions?
Buying securities
Mo
Mo
Securities auction
Selling securities
i
M1 & M2
i
M1 & M2
Price Stability
Day-to-day monetary operations mostly conducted through open market operations (OMO), while other instruments such as reserve requirement and moral suasion are rarely used.
Bank Indonesia sets interest rate target (BI rates since July 2005) and conducting OMO by auctioning Bank Indonesia Certificates (SBI) and Government Securities (SUN), intervening in the FX market and open window for deposits facility.
BI rate reflects the stance of monetary policy, that is the level of short-term interest rate BI wishes to maintain in order to achieve inflation target
Operational mechanism
OMOOMO
OMO RegulerOMO Reguler
OMO Non Reguler/Fine Tune Operation
OMO Non Reguler/Fine Tune Operation
SBI auctionSBI auction
FASBI/SWBIFASBI/SWBI
Reverse Repo SUN*)Reverse Repo SUN*)
SBI/SUN RepoSBI/SUN Repo
Contraction
Expansion
Contraction
Expansion
Fine Tune Contraction(FTK), Outright sale SUN
Fine Tune Contraction(FTK), Outright sale SUN
Fine TuneExpansion(FTE), Outright Buy SUN
Fine TuneExpansion(FTE), Outright Buy SUN
Sterilisation/Intervention(buy USD/IDR)
Sterilisation/Intervention(buy USD/IDR)
Sterilisation/Intervention(sale USD/IDR)
Sterilisation/Intervention(sale USD/IDR)
Characteristics of instruments
*) SBI FASBI SWBI SBI Repo* FTO Reverse Repo**
SUN Outright
Impact Contraction Reguler
Contraction Reguler
Contraction Reguler
Expansion Reguler
Contraction/ Expansion Non reguler
Contraction Reguler
Contraction/ Expansion Non reguler
Tenor 1 month
3 month o/n 7 days
7 days 14 days
o/n o/n – 14 days
< 3 month -
Units
Rp 1.000 mio
Rp 1.000 mio
Rp 500 mio
Max. 25% o/s SBI bank
Rp 1.000 mio
Rp 1.000 mio
Rp 1.000 mio
Increment
Rp 100 mio
Rp 100 mio
Rp 50 mio
Rp 100 mio Rp 100 mio Rp 100 mio
Mechanism Auction Non auction
Non auction
Non auction
Auction/ Non-auction
Auction/ Non-auction
Auction/ Non-auction
Interest rate
Auction result
Pre-determined
PUAS
PUAB o/n / SBI+200bp
Auction/pre-determined
Auction/ Pre-determined
-
Participants Bank, broker
Bank, broker
Bank/unit syariah
Bank Bank Bank, broker
Bank, broker
*)
Open market operations
Open market operations 1. Auctions of SBIs and or SUN 2. Deposit facility (FASBI)
3. FX sterilization/intervention
1. SBIs and SUN auction
Based on liquidity forecast, BI sets auction target (in volume) and announce to the market every Tuesday. Conducts weekly (every Wednesday) auction of SBIs, and occationally (non reguler) auction of SUN
Auction SBI-1 month every week, and SBI-3 month once a month
On a daily basis, BI closely oversees market liquidity by forecasting sources and uses of liquidity of commercial banks, in particular the movement of government accounts, changes in foreign reserves, and market condition
Open market operations
Open market operations
1. Auctions of SBIs and or SUN
2. Deposit facility (FASBI)
3. FX sterilization/intervention
2. Bank Indonesia deposits facility (FASBI)
On day-to-day, BI provides window facility for banks to deposit their liquidity with maturity o/n to one a week, aiming at smoothing the fluctuation of interbank money market rates.
FASBI rate o/n : BI rate – 200 bps
7 days: BI rate – 500 bps
BI also offers repurchase agreement (repos) on SBI and repos/reverse repos for SUN
Open market operations
Open market operations
1. Auctionsof SBIs and or SUN
2. Deposit facility (FASBI)
3. FX sterilization/intervention
3. Foreign exchange sterilization or intervention
As the cashier for the government financial transactions, BI provides FX for the government FX transactions, such as, payments of matured foreign debt, supply of FX for Pertamina originated from budget subsidy.
For managing liquidity in the domestic money market while smoothing the fluctuation of Rp exchange rate, BI occationally engages in selling (or buying?) FX (foreign reserves). This action is called intervention or sterilization.
Reverse Repo SUN
T+0
• Banks offer quantity and bid rate (reverse repo rate) during window time
Settlement first leg T+1
• BI debits bank’s account equal the amount won
• BI credit bank’s security (SUN) account
Second leg (RR-SUN at maturity)
• Banks sell back SUN
• BI credit bank’s account at the amount settled at the first leg + reverse repo rate
• BI debit bank’s SUN account
BANK
INDONESIA
BANKS Announcement
Auction RR-SUN (T-1)
Balance Sheets of Monetary Authority and Monetary System (Monetary Survey)
Neraca Sistem Moneter
Aktiva Pasiva
1. Aktiva Luar Negeri Bersih Uang Beredar (M2)/ Likuiditas Perekonomian
2. Tagihan Bersih pada Pemerintah Pusat 1. M1
3. Tagihan pada Lembaga - Uang Kartal
dan Perusahaan Pemerintah - Uang Giral
4. Tagihan pada Perusahaan 2. Uang Kuasi
dan Perorangan
5. Lainnya Bersih
Keterangan: format standar penyusunan neraca analitis ini adalah seperti yang dipublikasikan
kepada masyarakat dalam Statistik Ekonomi dan Keuangan Indonesia
Neraca Otoritas Moneter
Aktiva Pasiva
Aktiva Luar Negeri Bersih Uang kartal
Aktiva Dalam Negeri Bersih - di m asyarakat (uang kartal )
- Tagihan bersih pada pem erintah pusat - di bank um um - Tagihan pada sektor swasta dom estik Saldo giro (cadangan bank)
- Tagihan pada bank um um - m ilik bank um um
Aktiva Lainnya Bersih - m ilik m asyarakat
------------------------- Uang Prim er (M 0)