Monetary Policy and Exchange Rate in a Large Emerging Economy

This article examines the causal relation between monetary policy and an exchange rate for a large emerging economy, Indonesia. In the analysis, we employ a vector autoregressive (VAR) model comprising of the rupiah exchange rate, monetary policy variable (interest rate or interest rate differential...

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Bibliographic Details
Published in:Global business review 2023-10
Main Authors: Ibrahim, Mansor H., Sukmana, Raditya
Format: Article
Language:English
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Summary:This article examines the causal relation between monetary policy and an exchange rate for a large emerging economy, Indonesia. In the analysis, we employ a vector autoregressive (VAR) model comprising of the rupiah exchange rate, monetary policy variable (interest rate or interest rate differential) and inflation rate and use monthly data after the global financial crisis from 2009 to 2022. Our baseline result suggests that the rupiah exchange rate appreciates following monetary policy tightening. We note further that the appreciating effect of monetary policy is more apparent when the interest rate differential is used as an indicator of monetary policy and is robust to the addition of the fourth variable (alternatively the US inflation, market uncertainty and oil price) in the VAR framework. These results likely reflect the importance of central bank independence and inflation-targeting framework in enhancing the credibility of Indonesia’s monetary policy.
ISSN:0972-1509
0973-0664
DOI:10.1177/09721509231198659