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Monetary Policy Objectives


Bank Indonesia is mandated with achieving rupiah stability, maintaining the stability of the payment system as well as preserving financial system stability to support sustainable economic growth in accordance with Article 7 of the Bank Indonesia Act (Number 23) of 1999, as amended several times, most recently by Act Number 4 of 2023 concerning Financial Sector Development and Strengthening. Rupiah stability implies price stability of goods and services as well as rupiah exchange rate stability. In general, the performance of prices for goods and services is measured by low and stable inflation, while rupiah exchange rate stability is measured against other currencies. 

Rupiah stability in terms of low and stable inflation as well as exchange rate stability is critical towards achieving sustainable economic growth.  Moreover, rupiah exchange rate stability is necessary and an integral part of the efforts to support low and stable inflation.

​In pursuit of its mandate, Bank Indonesia adopted the Inflation Targeting Framework (ITF) as its monetary policy framework on 1st July 2005. ITF is relevant for the mandate and institutional arrangements mandated in prevailing laws. Based on ITF, inflation is the overriding objective. Nonetheless, Bank Indonesia continues to refine its monetary policy framework based on the changing dynamics and economic challenges faced in order to strengthen its effectiveness.​



Monetary Policy Framework

In the implementation of monetary policy, Bank Indonesia applies an Inflation Targeting Framework (ITF). ITF is a framework that orients monetary policy towards achieving a predetermined inflation target, which is announced publicly as a form of central bank commitment and accountability. ITF is implemented using the policy rate as a signal of monetary policy and the overnight interbank rate in Indonesia, namely IndONIA (Indonesia Overnight Index Average), as the operational target. The Inflation Targeting Framework was formally adopted by Bank Indonesia on 1st July 2005, replacing base money as the target of monetary policy.

 

Based on experience from the Global Financial Crisis in 2008/2009, an important lesson that emerged was the need for adequate central bank flexibility in response to more complex economic developments and a stronger financial sector influence on macroeconomic stability. Consequently, Bank Indonesia strengthened the ITF framework through its evolution into Flexible ITF. ​



Flexible ITF

Flexible ITF was developed around the core elements of the existing Inflation Targeting Framework (ITF), including a publicly announced inflation target and forward-looking monetary policy (monetary policy oriented towards achieving a predetermined inflation target in future periods due to the time lag effect of monetary policy). 

Public accountability of monetary policy remains an inherent element of Flexible ITF.  Flexible ITF was developed based on the following five core elements:

  1. Inflation targeting as the fundamental strategy of monetary policy.
  2. Integration of monetary and macroprudential policies to strengthen policy transmission, while maintaining macroeconomic stability.
  3. The role of exchange rate and capital flow policies to support macroeconomic stability.
  4. Strengthening policy coordination between Bank Indonesia and the Government to control inflation as well as maintain monetary and financial system stability.
  5. Strengthening the policy communication strategy as a policy instrument.​


Why Flexible ITF?

The Global Financial Crisis that occurred in 2008-2009 forced central banks to rescue the economy and maintain financial system stability.  Furthermore, policies that focused solely on ITF implementation were no longer considered sufficient due to the narrow monetary policy mandate of maintaining inflation in line with the target corridor, which was inadequate to maintain overall economic system stability.

 

The role of the financial system in the economy is increasing, with the impact of financial system instability becoming more significant.  This is reflected in the massive recovery costs and far-reaching impact of the Global Financial Crisis in 2008/2009.  Such conditions raised awareness of the critical central bank function to maintain financial system stability.  ITF implementation to maintain price stability, therefore, was necessary but not sufficient.

 

After the Global Financial Crisis, however, growing demand emerged for central banks to strengthen financial system stability in order to safeguard macroeconomic and financial sector stability.  To that end, successful ITF implementation required the support of a macroprudential regulatory framework.  Therefore, Bank Indonesia evolved ITF into Flexible ITF by strengthening its mandate to maintain price stability and preserve financial system stability. ​


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How is Flexible ITF Applied?

The overriding objectives of ITF and Flexible ITF are the same, namely to control inflation.  Notwithstanding, a nascent dimension that emerged from the Global Financial Crisis was the central bank's integrated role in maintaining financial system stability, while achieving the price stability mandate.  The embodiment of Flexible ITF is the flexibility to integrate monetary and financial system stability through a policy mix of monetary, macroprudential, exchange rate and capital flow instruments, while strengthening the institutional arrangements to optimise the role of policy coordination and communication.

 

In accordance with the inflation targeting strategy, Bank Indonesia announces the inflation target for a specific future period.  The inflation target is set by the Government in coordination with Bank Indonesia for the upcoming three years through a Minister of Finance Regulation (PMK).  Bank Indonesia regularly evaluates whether the inflation projections remain in line with the target corridor set.  The projections are based on several models and the various information available that depict inflation conditions moving forward as the basis for the monetary policies instituted.  This is due to the implications of the time lag effect of monetary policy, with the monetary policy target thus based on future inflation projections.  Efforts to achieve the target are implemented through a policy mix response based on transparency and accountability.

 

Seeking to strengthen the effectiveness of monetary policy transmission, Bank Indonesia set the BI 7-Day (Reverse) Repo Rate (BI7DRR) as the policy rate on 19th August 2016, representing the monetary policy response signal in terms of controlling inflation in line with the target corridor. Use of BI7DRR as the reference rate is part of the monetary policy reformulation performed by Bank Indonesia.

 

Previously, Bank Indonesia used the BI Rate as the reference rate, equivalent to a 12-month monetary instrument.  Through BI7DRR as the reference rate, however, the tenor of the monetary instrument was shortened to 7 days, which is expected to accelerate monetary policy transmission and steer inflation towards the target corridor.

 

There were three main objectives of the monetary policy reformulation.  First, strengthening the signal of monetary policy direction.  Second, strengthening monetary policy transmission effectiveness through its impact on interest rate movements in the money market and banking industry.  Third, accelerating financial market deepening, particularly in terms of transactions and formation of the interest rate structure in the interbank money market for tenors of 3-12 months.

 

In practice, monetary policy reformulation upholds four salient principles.  First, reformulation does not change the monetary policy framework as Bank Indonesia continues to apply flexible ITF.  Second, reformulation does not change the current monetary policy stance.  Third, reformulation ensures the policy rate is reflected in monetary instruments and is transactable with Bank Indonesia.  Fourth, determination of the operational target based on various considerations can be influenced by the policy rate.  Consistent with the second principle, reformulation does not change the current monetary policy stance because both the BI Rate and BI7DRR are part of the same term structure with regards to steering inflation towards the respective target.

 

The various aforementioned policies were strengthened through policy coordination with the Government, particularly on the supply side.  Government policy is predominantly oriented towards maintaining affordable prices, uninterrupted supply and distribution as well as effective communication in order to stabilise food prices and control inflation.  Policy coordination between Bank Indonesia and the Government to control inflation has been strengthened through the establishment of central and regional Inflation Control Teams (TPI).  In addition, policy coordination with the Government also reinforces financial system stability.  Through the Financial System Stability Committee, Bank Indonesia in conjunction with the Ministry of Finance, Indonesia Financial Services Authority (OJK) and Indonesia Deposit Insurance Corporation (IDIC) determine which coordination measures are necessary and provide recommendations in terms of monitoring and maintaining financial system stability.​


Monetary Policy Transmission

The overriding objective of monetary policy is to create and maintain rupiah stability, as reflected by low and stable inflation.  To that end, Bank Indonesia sets the BI-Rate as the main policy instrument that influences economic activity, with inflation as the ultimate goal.  The process of setting the BI7DRR to achieve the inflation target is transmitted through various channels with a time lag.

 

The monetary policy transmission mechanism is characterised by a variable time lag.  The time lag associated with each transmission channel is different.  Under normal conditions, the banking industry will respond to increases/decreases in the BI-Rate by raising/lowering interest rates.  Notwithstanding, if the banking industry detects higher risk in the economy, the response to a downward BI-Rate movement is slower.  On the other hand, in the case of banking industry consolidation to increase capital, lower lending rates and increasing demand for loans do not necessarily increase bank lending in response.  On the demand side, consumers may not necessarily respond to lower lending rates in the banking industry through higher demand for loans if the economic outlook is weak.  Therefore, the effectiveness of monetary policy transmission is affected by external conditions, the financial sector and banking industry, as well as the real sector.

 

In terms of the interest rate channel, adjustments to the BI-Rate influence deposit rates and lending rates in the banking industry. Bank Indonesia can utilise tight-bias monetary policy by raising interest rates, which impacts aggregate demand and alleviates inflationary pressures.  In contrast, reducing the BI-Rate will lower lending rates thus increasing corporate and household demand for loans.  In addition, lower lending rates also reduce the cost of capital for investment in the corporate sector, thus stoking consumption and investment activity and stimulating the economy.

 

Adjustments to the BI-Rate can also influence the exchange rate through the exchange rate channel.  A hike in the BI7DRR, for example, would increase the differential between interest rates in Indonesia and other countries.  A wider interest rate differential would attract non-resident investors seeking a higher rate of return to place capital in financial instruments in Indonesia. In turn, the foreign capital inflow would trigger rupiah appreciation, leading to cheaper imports and more expensive, or less competitive, exports from Indonesia, thus stimulating higher imports while simultaneously reducing exports.  Consequently, rupiah appreciation would ease inflationary pressures.

 

Adjustments to the BI-Rate​ also influence the macroeconomy through asset prices. Higher interest rates would lower the prices of assets, such as shares and bonds, thus eroding individual and corporate wealth and, in turn, undermining their ability to engage in economic activity, namely consumption and investment. This will reduce aggregate demand, prompting milder inflationary pressures.

 

The impact of changes in interest rates on economic activity also influences public inflation expectations through the expectations channel.  Lower interest rates stimulate economic activity an increase inflation, with workers thus anticipating higher inflation and, hence, demanding higher wages.  Producers subsequently pass on the cost of higher wages to consumers by raising prices.​


 
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Transparency and Accountability

According to the Bank Indonesia Act (Number 23) of 1999, as amended several times, most recently by Act Number 4 of 2023 concerning Financial Sector Development and Strengthening, Article 4, Paragraph (2) states that Bank Indonesia is an independent institution in the implementation of its duties and authority, free from government and/or third-party interference, unless explicitly stipulated in prevailing laws and regulations.  Institutional independence is accompanied by transparency and accountability.

 

Provisions concerning transparency and accountability have been given greater prominence, as stipulated in Article 58, namely that Bank Indonesia must submit written institutional performance reports to the President and People's Representative Council (DPR) in pursuance of its mandate.  The reports submitted to the President and DPR consist of quarterly and annual reports, parts of which are disclosed publicly via the mass media, including a summary in the State Gazette. At the beginning of each fiscal year, Bank Indonesia must disclose information publicly through the mass media containing: an evaluation of BI policy implementation in the previous year as well as the policy plan and targets to be achieved in the upcoming year.

 

In terms of the budget, Bank Indonesia compiles and presents annual financial statements to the President and DPR.  Bank Indonesia must complete the annual financial statements at least 30 (thirty) days before the end of the fiscal year and present the financial statements to the Audit Board of the Republic of Indonesia for auditing no later than 7 (seven) days after the annual financial statements have been completed.  Bank Indonesia must also publish the annual financial statements through the mass media.​


Monetary Policy Communication

BI policy communication is not only an aspect of transparency and accountability, but also an integral part of the monetary policy toolkit in the management of public expectations.  Central bank communication concerning current economic conditions, the policies instituted as well as projections and policy direction moving forward will influence public expectations and behaviour in terms of consumption, production and investment and reduce uncertainty. Warjiyo and Juhro (2016) found that communication plays an effective role as an instrument to form and guide public expectations.  Effective BI policy communication will influence public expectations, thus providing a toolkit that can impact real economic activity, including the prices of goods and assets, which are the target of the central bank.

​BI monetary policy is communicated through various media as follows:

  • Press Releases and Press Conferences
  • Publications, including the Economic Report on Indonesia, Monetary Policy Report, Monetary Policy Review
  • Bank Indonesia website
  • Talk shows aired on radio and television
  • Seminars/Discussions with stakeholders
  • Regional dissemination

Warjiyo, P., & Juhro, S. M. (2016). Central Bank Policy: Theories and Practices. PT. RajaGrafindo Persada ​


Coordinated Inflation Control

Low and stable inflation is a prerequisite for public prosperity in line with the macro policy goals.  Nevertheless, sources of inflationary pressures not only originate from the demand side, which can be managed by Bank Indonesia, but also stem from the supply side in relation to the production and distribution of goods.  In addition, inflation shocks may also emerge due to government policy concerning administered prices, such as fuel and other energy prices.  A policy mix is required, therefore, to achieve low and stable inflation.

 

Bank Indonesia coordinates with the central and local government to control inflation.  Meanwhile, the Government also plays a role in terms of controlling inflation expectations and managing supply, including the management of supply, distribution, connectivity, supply chain and subsidies.  Synergy between Bank Indonesia and the Government is leveraged to control inflation within the predetermined target corridor through the establishment of inflation control teams (TPI). A central inflation control team (TPI) was established in 2005, with regional inflation control teams subsequently formed since 2008.

 

Coordinated inflation control was strengthened through Presidential Regulation (Perpres) Number 23 of 2017 concerning the National Inflation Task Force (TPIN) as a legal foundation. The Presidential Regulation stipulates the coordination mechanism for inflation control through the formation of a Central Inflation Control team (TPIP), as well as Regional Inflation Control Teams (TPID) at the provincial and city/regency levels.

 

The legal foundation was subsequently strengthened by promulgation of Coordinating Minister of Finance Regulation Number 10 of 2017 concerning the Mechanisms and Procedures for TPIP, Provincial TPID and City/Regency TPID, Coordinating Minister of Finance Regulation No. 148 of 2017 concerning the Tasks and Membership of Working Groups and TPIP Secretariat, and Minister of Home Affairs Decree No. 500.05-8135 of 2017 concerning the Regional Inflation Control Teams (TPID).  The inflation control program focuses on 4K principles as follows:

  • Affordable prices
  • Available supply
  • Uninterrupted distribution
  • Effective communication

In conjunction with TPIP & TPID, Bank Indonesia remains firmly committed to controlling inflation nationally, including in synergy with the National Movement for Food Inflation Control (GNPIP). ​



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Inflation

Monetary Indicator

BI-Rate

Monetary Operation

IndONIA & JIBOR

Exchange Rate

Money Market

Sharia Economy and Financial Development

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