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TANJUNGPINANG, KEPULAUAN RIAU] Date: 19 January 2016, At: 22:07
Bulletin of Indonesian Economic Studies
ISSN: 0007-4918 (Print) 1472-7234 (Online) Journal homepage: http://www.tandfonline.com/loi/cbie20
“Indonesian Monetary Policy”: A Rejoinder
George Fane
To cite this article:
George Fane (2000) “Indonesian Monetary Policy”: A Rejoinder, Bulletin of
Indonesian Economic Studies, 36:3, 71-72
To link to this article:
http://dx.doi.org/10.1080/00074910012331338973
Published online: 18 Aug 2006.
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Vol 36 No 3, December 2000, pp. 71–2
Bulletin of Indonesian Economic Studies
‘INDONESIAN MONETARY POLICY’:
A REJOINDER
George Fane
Australian National University
My article in this issue (pp. 49–64) makes two main points. First, because changes in the velocity of base money were small relative to the huge expansion in its level, Grenville’s favoured policy of targeting domestic prices would have been similar to the IMF’s policy of targeting base money, while both would have been totally different from the actual policy in which base money was expanded by far more than was needed to accommodate the banking panic. Second, almost as soon as base money was kept to the announced targets, inflation was halted and the exchange rate appreciated.
Grenville never mentions either point. Instead he sets up a straw man by interpreting the policy of targeting base money to mean that it is rigidly kept to an announced day-to-day path, but that the banks continue to hold the minuscule reserves that are optimal for them under the quite different regime in which the central bank stands ready to provide whatever liquidity is needed each day to allow the banking system to clear at roughly unchanged interest rates. This implicit assumption of unchanged behaviour despite a radical change in the policy regime that conditions that behaviour is an excellent example of the fallacy exposed by the Lucas critique.
I accept Grenville’s criticism that I misquoted him on US monetary policy, but reject the significance that he attributes to my error, both because I did not advocate rigid day-to-day targeting of base money and because imposing rigid day-to-day base money targets would not lead to regular failures of the clearing system, but would rather force banks to hold increased deposits at the central bank. However, I do not believe that it is an optimal policy either, and I did not deal with it in my article, where I defended the policy of base money targeting in the way that it was proposed by the IMF for the Asian currency countries: quarterly
72 George Fane
and annual targets were announced, with the intention that monetary policy would be somewhat tightened, or loosened, depending on whether the latest observation on base money was above, or below, the target. Grenville argues that Korea and Thailand were not really targeting base money because, over the first 12 months of their plans, base money was scheduled to grow but actually fell. He says that this proves the impossibility of targeting base money—‘a target is not a ceiling’. Here again, he is adopting the rigid interpretation of base money targeting. He seems not to notice that his own preferred policy of targeting inflation could be reduced to absurdity by interpreting it to mean that monetary policy must be adjusted on a day-to-day basis to keep an index of domestic prices exactly to a rigid pre-announced path. In the crisis of confidence of 1997–98 it was much more important to reassure markets that there would not be an explosion of the money supply than to prevent it falling below the target. If Bank Indonesia had adopted Grenville’s advice and set a target of, say, 20% for annual inflation, and if prices had instead fallen slightly, it would be a severe critic who claimed that this ‘failure’ proved the impossibility of inflation targeting.
