CENTRAL BANK POLICY MIX

Dr. Solikin M. Juhro Executive Director, Head of Bank Indonesia Institute Bank Indonesia

2018 2 KEY MESSAGES

Post-GFC Economic Challenges Challenges Ahead: Lessons Learned from the GFC

• Maintaining Growth under ‘The New From Standard ITF to Flexible & Normal’ Inregrated ITF: Road to CB Policy Mix • Managing Digital Economy Uprising

• Monetary & Macroprudential Policy Integration Policy Mix • Capital Flow Management (“Integrated Policy Framework”)

Closing 3 Flashback: Targeting Framework (ITF) UU No.23 Tahun 1999 menjadi dasar bagi Bank Indonesia untuk menerapkan kerangka kerja Inflation Targeting sbg kerangka kerja kebijakan moneter di Indonesia (secara formal pada 1 Juli 2005) …. No Kriteria Bernanke et al. (1999) Svensson (2000) King (2004) 1. Kestabilan harga sebagai tujuan Ya Ya Ya utama kebijakan moneter 2. Pengumuman target inflasi Ya Ya Ya 3. Target inflasi jangka menengah Tidak jelas Ya Ya 4. Komunikasi intensif dengan publik Ya Ya Ya 5. Penggunaan kaidah kebijakan Tidak jelas Penargetan Penargetan inflasi + respon (rule) moneter secara spesifik prakiraan inflasi thd sisi penawaran 6. Publikasi prakiraan inflasi dan Tidak perlu Ya Tidak jelas output 7. Target ditetapkan oleh pemerintah Ya Tidak perlu Tidak perlu (goal dependence) 8. Penggunaan instrument secara Ya Ya, tetapi tidak Ya independent (instrument disebutkan secara independence) tegas Post-GFC Challenges: Managing Monetary & Financial Stability in a Dynamic Global Environment

Macroeconomic Stability Dynamic Global (GDP Growth and Inflation) Openness and Environment Integration

World GDP Procyclicality Trade Channel Real Sector World Inflation Risk Taking (Commodity Financial Prices) Behaviour Accelerator Financial Sector World Interest Financial Channel Rate

Financial Stability (Credit Growth, Asset Price, Default Risk) Geopolitics

4 Post-GFC Challenges: From VUCA to TUNA

GREATER SHOCK & IMPACT

Volatility Turbulency

Uncertainty Uncertainty M onetary Policy Trade War Normalization Capital Outflow from EM Globally

Trumponomics? Complexity Novelty Turkey Geopolitics Oil Price Volatility Ambiguity Ambiguity US-North EU Post Brexit? Korea Relation

5 (Im)Possible Trinity Solution

Policy Trilemma.... “overtime, the three goals cannot be attained simultaneously” (Mundel, 1968). “only two out of three“ conditions above can be applied together”

“The impossible trinity was managed by preferring middle solutions of open but managed capital account and flexible exchange rate but with management of volatility.Rather than relying on a single instrument, many instruments have been used in coordination.”(Mohan andKapur,2009).

(Im)possible Trinity Evaluation in EmergingMarkets Policy Trilemma

Free Capital Flow

1 : 1 :0 “can reach only two ofthree” Vs.

Source: Juhro,2014 2/3 : 2/3 :2/3 “possible to manage thethree” 6 Lessons Learned ….

. “There is no macroeconomic stability without financial stability”. Maintaining price stability, without maintaining financial system stability is not enough (insufficient) to achieve macroeconomic stability. . Capital flow dynamics lessen effectiveness.

. Exchange rate dynamics are largely influenced by investor risk perception; need for managing the exchange rate in order to avoid excess volatility.

 The multiple challenges as a result of dynamic capital flows imply that monetary authorities should employ multiple instruments (a policy mix).  It requires integration of monetary and macroprudential policy, including capital flow management and exchange rate policy.  Managing the ‘Trilemma’: Impossible Trinity vs Possible Trinity 7 7 Post-GFC Central Bank Policy: Pivotal Linkages

CENTRAL BANK Payment System Monetary Policy

Policy Banking Policy

2008/09 GFC Monetary Payment System Individual Bank Pre Stability Stability Soundness (Idiosyncratic Risk)

LINKAGES…?

CENTRAL BANK FSA

Payment System Monetary Policy Macroprudential Microprudential

Policy Policy Policy

GFC 2008/09 st

Monetary Payment System Financial Stability Financial Institution Po Stability Stability (Systemic Risk) Soundness 8 Post-GFC Central Bank Policy: Pivotal7 Linkages

Monetary Policy • • Liquidity Monetary Exchange rate • Interest rate • Stability Capital flows M • Intervention • • A • Foreign exchange flows C • International reserve • Credit growth management • Funding & lending interest rate R • Exchange rate • Bank liquidity O Macroprudential Policy S • Leverage Ratio • Systemic risk • CCB, Capital Surcharge • Lending imbalances Financial T • LTV, DTI • Intermediary & financial access System Stability • GWM-LDR • The efficiency of the financial system A • LCR, NSFR B • SBDK, LKD. I • Liquidity risk Payment System & • Access to financial system L Currency Mgt Policy I T Intraday liquidity facility • • Settlement risk Less Cash Policy Y • • A smooth transaction Payment • Sufficient amount of • The efficiency of the payment system Rupiah (cash) • Public confidence in the System Stability • The use of the Rupiah • payment system 9 From ITF to Flexible ITF Mishkin (2011): “none of the lessons from the financial crisis in any way undermines the nine basic principles of science of monetary policy”.

Standard Inflation Targeting Framework (ITF) Flexible ITF was built while remaining which solely rely on interest rate policy to Enhancement grounded in the important elements achieve the inflation target is not always of the ITF that had been built. effective in EM countries. (Juhro & Goeltom, 2012; Juhro, 2016)

Forward- Reports looking Key Elements of Flexible ITF

DECISIONS

Transparency Inflation remains the Monetary policy and Strengthening Communication main target of macroprudential exchange rate policies Economics monetary policy. policies integration & capital flows Research & Analysis Committee Meeting

Monetary Policy Strengthening policy Strengthening policy Committee coordination between CB & communication as part of policy Government instruments. Board of Governors Monetary & Macroprudential Policy Integration

“Macroprudential policy seeks to develop, oversee and deliver appropriate policy responses to the financial system as a whole. It aims to enhance the resilience of the financial system and dampen systemic risks that spread through the financial system”. (The G-30).

Monetary Policy Macroprudential Policy

Desired Economic Cycle Downswing

Monetary and macroprudential policies are countercyclical measures to reduce magnitude of the business and financial cycles and they are reinforcing each other. 11 20 Monetary & Macroprudential Policy Integration20 Monetary Mix

* (Optimal credit growth) High inflation 푲

Monetary Policy Monetary Policy

Macroprudential Policy Macroprudential tools

Expected Optimal Π* inflation rate condition

Monetary Policy Monetary Policy Monetary Stability Macroprudential Policy Macroprudential Policy

Low inflation N ote: Contractionary Low credit Financial Stability High credit policy growth growth Expansionary policy Capital Flow Management (CFM)

The IMF’s “institutional view” (2012): CFMs refer to measures that are designed to CFM’s Instruments: Prudential & Administrative limit capital flows, and encompass both measures that discriminate on the basis of residency and those that do not. Prudential Administrator

Goals of Capital Flow Management Tax on non-resident Net Open Position Residents capital flows . Support exchange rate stability, Banks and prevent the risks of balance of Limit on Bank’s short payments crises and sudden-stop term Non-remunerated capital reversal. reserve requirement Capital . Mitigate pro-cyclical and systemic Capital Flow Hedging Ratio Flow risks from external debt

accumulation and the volatility of Liquidity ratio on Specific licensing foreign capital flows. External Debt Repayment Capacity Firms Minimum Credit Non- Rating for External Restrictions Residents Macroprudential measures refer to measures Debt Borrower that are designed to limit systemic financial risks, including risks associated with capital flows. 13 Integrated Policy Responses to Capital Flows (Indonesia’s experience)

Monetary Policy Capital Flows Macroprudential Structural Policy Measures Management Measures

Increase RR Rp. and FX and Sterilized FX market Secondary RR Financial market intervention deepening (FX Limiting Short Terms Borrowings Exposure of Banks market, bonds (eg 30% capital) Dual intervention (FX and Minimum Holding market and money bonds intervention periods for short market) simultanously) term bills (CB bills) Risk Management of Corporate FX borrowings - Increase duration (hedging requirement, FX during inflows liquidity req, credit rating) Interest rate - Reduce duration LDR-linked reserve during outflows requirement Export proceed regulation Loan To Value Ratio for FX Reserve Housing Loans and Down acummulation Payment Rule for Automotive Loans 14 Bank Indonesia’s Trilemma Management Policy instrument mix is an important strategy to optimally manage monetary policy trilemma

Monetary and Macro-prudential Policy (instrument) mix Maintaining monetary policy autonomy to achieve price stability and financial stability • Interest rate to address inflation expectation • Macro-prudential measures to manage liquidity and financial stability

Exchange Rate Management Capital Flow Management Stabilizing exchange rate movement in line with Managing capital flow to support macroeconomic its fundamental stability • Foreign exchange intervention to smooth out ER • Macroprudential to manage capital flow, volatility especially short term and prevent external sector risks • Manage foreign exchange reserve adequacy: (i.e. sudden stop capital reversal) . acummulate FX reserves during inflows and • Promote financial deepening (FX market, bonds use the reserve during outflows (self insurance) market, money market) • Support foreign exchange reserves management as a Source: Juhro & Goeltom,2012; Juhro, 2015 form of self-insurance. 15 CB Policy Framework under Flexible ITF

Operational Targets / Intermediate Policy Instrument Overriding Transmission Channels Targets Objective

Monetary Instruments - Interest Rate Policy Trilemma: - Policy Rate - Exchange Rate - Monetary Autonomy - Forex Intervention - Credits/liquidity - Exchange rate stability in line Monetary Stability - Liquidity Management - Expectation with fundamental (Price Stability) - Managed capital flows Macroprudential Instruments Risk potential/perception: Regulation on: - Liquidity risks - Financial Resilience Financial System Stability - Liquidity - Credit risks - Credit - Balanced intermediation - Market risks - Financial Inclusion - Capital Solvency Macroprudential Surveillance

Communication

Policy Coordination

Source: Juhro & Goeltom, 2012 16 Flexible vs. Integrated ITF: Road to CB Policy Mix

Source: Agenor and Da Silva (2019) 17 Challenges Ahead: Macroeconomic Stabilization under “The New Normal”

Medium-Long Term Perspective: Medium-Long Term Perspective: Cyclical Demand Management + Structural Policy/Reform Cyclical Demand Management + Structural Policy/Reform

StateState of of the the economy economy StructuralStructural reform reform to minimize potential potential shocks shocks and and enhanceenhance economic economic capacity capacity for for sustainablesustainable growth ShortShort Term Term Perspective: Perspective: Cyclical Demand Management Cyclical Demand Management EconomicEconomic capacitycapacity

Counter-cyclicalCounter-cyclical policypolicy toto manage manage cyclicalitycyclicality

Source: Juhro,2015 18 Challenges Ahead: Digital Economy Uprising

Domestic Prospects Global Prospects • Efficiency vs stability Money vs technology • Domestic economic recovery Global economic recovery • Intermediation form • Crossborder payments & structural reforms Increase in commodity prices Lower current account deficit

Pressure on Currency from Global Increasing Pressure on Global Inflation Increasing Pressure on Inflation: US Policy: Increase in administered prices & volatile foods prices Fiscal Expansion & Tight Monetary Relaxing the Financial Regulations Optimizing monetary transmission: Slow decrease on lending rates EU: Increase in Geopolitical Risk Weak overall lending figures Financial Stability: Populism Banking & corps consolidation Credit risk: NPL

GLOBAL Challenges DOMESTIC Central Bank Policy Mix “Integrated Policy Framework” Central Bank Policy Mix is directed at continuing to strengthen economic stability and maintain the momentum of

The central bank's POLICY COORDINATION with the Government's and structural reforms is SUFFICIENT Central Bank Policy to promote high and inclusive growth, while maintaining Fiscal Policy macroeconomic and financial system stability. • Goal: Maintaining price • Maintaining stability and supporting macroeconomic stability financial stability Central Bank through credible fiscal Kebijakan Bank KebijakanFiscal Policy Fiskal SentralPolicy deficits and public debt. • Mix of instruments: interest rates, exchange rates, • Tax policies and capital flow allocation of productive Reformasi management, and Structural expenditures for high StrukturalReform macroprudential policies and inclusive growth stimulus.

Structural Reform

• Achieve high growth through the productivity of capital, labor, and technology improvements. • Reforms in infrastructure, investment climate, trade and labor sectors. Source: Warjiyo & Juhro, 2016 Coordination in Indonesia Policy coordination between Bank Indonesia (BI), the Government and related authorities will continue to be promoted to maintain macroeconomic stability and encourage economic growth...

DIGITAL ECONOMY & INFLATION CONTROL FINANCIAL SYSTEM STABILITY 1 3 5 FINANCE

National & Regional Inflation Control KSSK (FSS Committee). Prevention and •  Coordination between BI- Team (TPI & TPID). Programs to cope handling of financial crises. OJK on digital financial with availability of supply, affordability Harmonization of BI-OJK (FSA)'s macro- • policies in the payment of price, smooth distribution, eEffective prudential-microprudential policies. system with digital financial coordination. BI-LPS (Deposits Insurance Corp.) • policies to encourage Coordination. financial intermediation. IMPROVEMENT OF  Coordination across FINANCIAL MARKET ministries and agencies to 2 ECONOMIC STRUCTURE build a digital economic & 4 DEEPENING financial ecosystem. Quarterly Coordination Meeting  Establishment of a National The FK-PPK (Coordinating Forum for between Central-Regional Committee for the Financial Market Deepening) focused on Governments and BI (Rakorpusda) development of digital innovating economic financing focused on improving the current finance. account deficit, investment instruments through financial markets, financing, especially infrastructure, infrastructure development and and the development of digital expanding the investor base, and economy & finance. harmonizing regulations 21 Technical Aspect of Implementation Several aspects that need to be considered to make instrument mix work optimally: (Juhro, 2014):

signals (source of risks) Origin, trigger, built-in period, necessary to elicit a impact, indicator (EW). response Clear signals, facilitating public accountability, info sharing, “balancing act”.

Macroprudential policy policy response communication rule: cyclical & cross characteristic sectional risks. Mix policy rule?

Developing theoretical effectiveness and timing of Different lag/frequency framework. Policy calibration of policy implementation & Timing to activate/end policy modeling & simulation. measures (pro)cyclicality responses

22 Closing

. Against the backdrop of a dynamic global environment, multitude of challenges confronting the EMEs demand a policy mix response utilizing multiple instruments.

. In the initial period of post-GFC, monetary policy framework enhancement in Indonesia is, in general, characterised by the ‘Flexible’ ITF. It continues to adhere to an inflation target as the overriding objective of monetary policy. The main characteristics of ITF remain; yet, ITF is implemented in a more feasible way.

. Further framework enhancement implies that central bank policy mix is ultimately part of an important strategy to optimally manage central bank policy trilemma in the current climate blighted by widespread uncertainty.

. Under central bank policy mix, strengthening policy coordination between central bank and government is SUFFICIENT, in maintaining the momentum of economic growth, while safeguarding monetary and financial system stability.

23 THANKTHANK YOUYOU

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