INFLATION TARGETING FRAMEWORK (ITF)

:: Definition on ITF

The ITF is a monetary policy framework marked by announcements to the public on the inflation target to be achieved over the next several periods. In explicit terms, low, stable inflation is described as the overriding objective of monetary policy. According to the definition given earlier, Indonesia, following the promulgation of Act No. 23 of 1999, can be categorized as one of the "Inflation Targeting Lite countries."

:: Reasons for Selection of the ITF

1. The selection of the IT monetary policy framework is based on the following considerations :
   • Complies with sound monetary policy principles.
   • Is consistent with the mandate of Act No. 23 of 1999 concerning Bank Indonesia as amended by Act No. 3 of 2004.
   • Research points to the growing difficulty of controlling monetary aggregates.
   • Empirical experience in other countries indicates that countries applying the ITF have succeeded in curbing inflation without increasing output volatility. The framework could strengthen BI's credibility as the institution responsible for inflation control through commitment to achievement of the target
2. Application of the ITF does not mean that the central bank pays attention only to inflation and no longer takes economic growth and overall policy and economic trends into consideration. Furthermore, the ITF is not a rigid rule, but a comprehensive framework for formulating and implementing monetary policy. The focus on inflation does not mean guiding the economy towards a condition of zero inflation. \
3. Low, stable inflation in the long-term will in fact provide support for sustainable growth. The reason is that inflation has a positive correlation with fluctuation in the inflation rate. When inflation rises, so does the rate of fluctuation, and the public no longer has assurance regarding the existing level of inflation. As a result, long-term interest rates will rise because of the high risk premium brought on by the inflation. Business planning will become more difficult and investors will lose interest. Investors faced with uncertainty over inflation will prefer short-term financial assets over long-term real investment. For these reasons, monetary authorities frequently put forward the argument that an anti-inflation policy is in fact pro-growth policy.

:: Inflation Target

1. The inflation target represents the overriding monetary policy objective set by the Government after coordinating actions with Bank Indonesia. The determination of the inflation target considers the trade-off with economic growth in the effort to improve the living standards of the population.
2. After coordinating with BI the Government set the inflation target for 2008, 2009, and 2010 at 5±1%, 4.5±1%, and 4±1%.

:: Monetary Policy Indicators 

1. When formulating monetary policy, Bank Indonesia will always analyze and take into consideration various economic indicators, most importantly the forecasts for inflation, economic growth, monetary aggregates, and developments in the overall economic and financial sector.
2. Similarly, Bank Indonesia will continually pay close attention to the economic policy actions pursued by the Government. Policy coordination measures that are operating smoothly will be strengthened and improved over time.
3. The analyses and forecasts for these economic variables are taken into account in order to maintain a course in which the inflation forecast is consistent with the established inflation targeting range.

:: Respon Kebijakan Moneter

1. The objective and nature of the monetary policy stance are as follows:
   • The monetary policy stance is determined with the objective of consistency, i.e., to ensure that future inflation and economic developments remain on track with achievement of the established inflation target
   • The monetary policy stance is expressed as an increase, decrease, or no change in the BI Rate.
   • Any change in the BI Rate (increase or decrease) will be phased in consistently over time.
2. The BI Rate function as a policy signal
   • The BI Rate is the signaling interest rate instrument for Bank Indonesia and is determined in the quarterly Board of Governors' Meeting for the coming quarter, unless decided otherwise in a monthly Board of Governors' Meeting within the same quarter. Accordingly, the weighted average SBI rate formed in the SBI auction is no longer interpreted by stakeholders as a signal of Bank Indonesia monetary policy.
   • The BI Rate is announced to the public immediately after adoption in the Board of Governors' Meeting as the monetary policy stance (with greater clarity and assurance) in responding to the outlook for achievement of the inflation target.
   • The BI Rate is used as a reference in monetary control operations to ensure that the weighted average 1-month SBI rate formed in Open Market Operations auctions (the liquidity adjustment instrument rate) remains at around the level of the BI Rate. The 1-month SBI rate is then expected to influence interest rates on the interbank money market and longer-term interest rates.
3. Determining the monetary policy stance
   • The monetary policy stance is determined in the quarterly Board of Governors' Meeting.
   • The monetary policy stance is adopted for a period of one quarter in advance.
   • The determination of the monetary policy stance takes account of the monetary policy lag in influencing inflation.
   • Under unusual circumstances, the monetary policy stance may be determined in a monthly Board of Governors' Meeting.
4. Basis for determining the policy stance
   • The BI Rate is the central bank response to future inflationary pressure in order to keep inflation on track with the established target. Changes are made in the BI Rate primarily if the deviation in the inflation projection from the target (inflation gap) is deemed permanent and is consistent with other information and indicators.
   • The BI Rate is adopted at the discretion of the Board of Governors after taking into account:
     • The recommendation for the BI Rate generated by the policy reaction function in the economic model for achievement of the inflation target, and
     • Other information, such as leading indicators, surveys, anecdotal information, information variables, expert opinions, assessment of risks and uncertainties, and economic and monetary policy research.
5. The monetary policy stance is expressed in consistent, gradual changes in the BI Rate (1-month SBI) in multiples of 25 basis points (bps). Under conditions indicating the need for more intense response from Bank Indonesia for achievement of the inflation target, the change in the BI Rate may be greater than 25 bps, as long as it is made in multiples of 25 bps. 

:: Monetary Control Operations

1. In contrast to the previous practice of relying on base money, the operational target in monetary control is now the BI Rate. With the use of the BI Rate, monetary policy signals are expected to be more easily discernable and provide greater certainty for market players and the public. For this reason, the BI Rate is also expected to improve effectiveness in the operation of monetary policy.
2. Monetary control takes place through the use of the following instruments: Open Market Operations (OMO); standing facilities, (iii) intervention on the forex market, (iv) establishment of the minimum statutory reserve requirement, and (v) moral suasion.
3. Monetary control is also aimed at keeping interbank money market rates within the established interest rate corridor. This has a two-fold purpose of more effective liquidity control and reinforcing the monetary policy stance adopted by Bank Indonesia

:: Coordination with the Government

1. The purpose of coordination with the Government is to ensure that Bank Indonesia monetary policy is aligned to the general economic policy of the Government while maintaining clarity in the powers and functions of each side.
2. Bank Indonesia's coordination with the Government in establishing the inflation target operates under the terms of an MoU between the Government (c.q. Minister of Finance) and Bank Indonesia that includes the following:
   • Bank Indonesia shall submit an Inflation Target proposal to the Government by the end of May each year, before the end of the inflation targeting period.
   • Under unusual circumstances in which the existing Inflation Target is no longer realistic and needs revision, Bank Indonesia shall submit a proposal for an amended Inflation Target after coordinating with Bank Indonesia.
3. The importance of Government involvement in determining inflation is based on consideration of several factors. First, not all sources of inflation come under the policy control of Bank Indonesia. Government policy also contributes to inflation. This includes the setting of administered prices, the regional minimum wage, civil servant salaries, and policies in specific production sectors, domestic commerce, and restrictive import schemes. Other government policies (e.g., in the areas of politics, security, and law enforcement) also have an indirect bearing on inflation. Second, a joint commitment on inflation control that is set out on paper between the Government and Bank Indonesia will give the inflation target greater credibility, as it is then a "joint undertaking." If the inflation target enjoys strong credibility, meaning that it is regarded as an achievable task for Bank Indonesia and the Government, economic actors will bring their inflation estimates into line with the inflation target. If this happens, the Government and Bank Indonesia will find it easier to curb and stabilize inflation over the medium and long-term without having to shoulder excessively high policy costs.
4. In follow up to the MoU, Bank Indonesia and the Government established the inflation targeting, monitoring, and control team (or Inflation Control Team) with members drawn from several line ministries. The tasks of the team include preparation of proposals on the inflation target, evaluation of sources and potential for inflationary pressure and the impact of this pressure on achievement of the inflation target, recommending policy choices that support achievement of the inflation target, and disseminating public information on the inflation target and actions taken for achievement of the target. The establishment of the Inflation Control Team is expected to strengthen overall coordination between the monetary authority and the Government so that the inflation target becomes a credible, achievable joint objective.
5. Bank Indonesia also coordinates with the Government in the determination of macro assumptions for preparation of the Draft Budget. This may take place in coordinating meetings with the Ministry of Finance (and relevant agencies) and in deliberations with the Indonesian Parliament.
6. Bank Indonesia coordinates with the Government in other areas of economic policy at Cabinet Sessions and in other meetings as appropriate to developments and the issues that arise.

:: Transperancy

1. Monetary policy is constantly communicated to the public to build the credibility of monetary policy in shaping expectations and achievement of the inflation target.
2. The scope of communication of monetary policy covers announcement and explanation of achievement of the inflation target, the monetary policy framework and policy actions that have and will be taken, the schedule for the Board of Governors' Meetings, and other matter as determined by the Board of Governors.
3. Monetary policy communications are conveyed by means that include but are not limited to press releases, press conferences (mainly immediately following the Quarterly Board of Governors' Meeting to explain the monetary policy response), publications (including publication of the Monetary Policy Report or Inflation Report), and other information presented directly to the public.
4. Monetary policy communications are conveyed directly to the general public, including but not limited to the media, economic actors, experts, and academics.

:: Accountability

1. An accountability report for monetary policy is presented to the Indonesian Parliament as a means of building the credibility of Bank Indonesia in the performance of the powers and functions stipulated in the law.
2. Accountability of monetary policy is provided through written submissions and verbal explanations of the quarterly Monetary Policy Report or Inflation Report and of certain aspects of monetary policy as deemed necessary.
3. The Monetary Policy Report is also presented to the Government and public for purposes of transparency and coordination.
4. If the inflation target for one year is not achieved, Bank Indonesia shall provide the government with proposed explanations to be used as material for joint explanations by the Government and Bank Indonesia in open session at the Indonesian Parliament and to the public.