In other words, the central bank is considered to be indifferent to the positive and negative output gap. And whether the central bank really doesn't care about the negative output gap and the positive output gap. In the monetary policy preferences for symmetry of the output gap, the central bank is assumed to be indifferent between the positive output gap and the negative output gap.
Asymmetric preference illustrates the different treatment of the central bank (asymmetry) in the case of recession and boom or in response to positive and negative deviations of output (unemployment) and/or inflation from the target. However, if the output gap is negative, the central bank's losses will increase exponentially.
Previous studies
The symmetric loss function (quadratic) shows that if there are positive and negative deviations of production from its potential value by the same amount, this will give an amount of loss that is equally large. But in an asymmetric function, if there is a positive deviation of output from its potential (a positive output gap), the central bank's losses will increase linearly. Thus, in the context of the linex function, the central bank's preferences are asymmetric with respect to the output gap, whereby the central bank will respond to a negative output gap with a policy that carries more weight than a positive output gap in order to reduce losses.
The results showed that the Barro-Gordon model was able to explain the behavior of long-term inflation and unemployment in the periods of leadership Burn and Miller, Greenspan, after the appointment of Volcker, and for the overall analysis (full sample). While in the short term, the Barro-Gordon model was only relevant during Greenspan's tenure. The time discrepancy of the Barro-Gordon Model, as described earlier, explained that the inflationary bias in the economy was caused by the central bank being too ambitious to reduce unemployment below the natural rate or to stimulate output to exceed its potential level.
Although some previous studies presented demonstrate the validity of the Barro-Gordon model in some countries, the evolving Barro-Gordon assumption raised doubts and questions from many theoretical, practical and empirical monetary academics and practitioners. Regime change is expected to cause changes in the degree of time mismatch and average inflation bias. The results showed that the target inflation and the average inflation bias in the pre-Volker regime is 3:42% and 1.01%.
Furthermore, the study also indicated that the Bank of Korea's monetary policy places excessive weight on the positive deviation of inflation from its target in the case of a negative deviation.
METHODOLOGY 3.1. Variables and Data
Empirical Model
The model used in this study is a linear exponential model (linex) that contains the policy preferences of the asymmetry parameter. The behavior of economic actors forms expectations based on the Augmented Phillips Curve:. yt is the output gap, the deviation of the actual output from the potential value. pt inflation is a period t and pet is the expected inflation period t formed in period t-1. ut is a supply shock that could possibly occur under the autoregressive ut = ρut-1 + εt where ρ א [0,1] and εt isi.i.d shock with zero mean and constant variance σ2t. In addition, the private sector has rational expectations, which is expressed by the following equation:. Et-1 represents the formation of inflation expectations for period t based on the information available in period t-1. In addition, the central bank is believed to control inflation completely and directly by minimizing the following function:.
To obtain asymmetric preference parameters, the loss function is given in the form of a linear exponential. Therefore, according to Ruge-Murcia (2002), it is very important to test whether γ is significantly different from zero or not to show the time inconsistency of monetary policy. The time inconsistency of monetary policy arises because the asymmetry of policy preferences is driven by the desire to achieve central bank output that exceeds its potential value, as represented by the parameter γ.
The level of central bank conservatism can be indicated by the number l and γ. The more conservative the central bank's monetary policy preference, the smaller the output stabilization (l), and policymakers' preferences for output symmetry would be indicated by the low value of absolute γ. Here Et-1yt is the conditional mean of the output gap and σ2y,t is the conditional variance of the output gap.
The mean inflation measure p* is assumed to be normally distributed around a constant c, and εt is the reduced form disturbance.
Estimation Techniques
ARIMA (p, d, q) is a combination of AR (p) and MA (q), where p is the order of autoregression, d is the order of integration, and q is the order of moving average. The choice of ARIMA (p, d, q) or ARMA (p, q) model will depend on the degree of integration or stationarity of the output gap. If the data at the level of the output gap are stationary, the estimated expected value of the output gap is done using ARMA (p, q).
However, if the output gap is integrated in first differences or higher order, the estimation will be done by ARIMA (p, d, q). First, determine the model or degree of data integration and the order of ARIMA stationarity. Second, the estimated model parameters were based on the identification results. Third, it is a diagnostic check and selection of the best model based on several criteria: (i) coefficients that were statistically significant (in terms of statistics and t or p-values), (ii) random error or white noise (indicated by the Q statistic exceeds 5% confidence level (Q statistic > . α)) and (iii) least standard error regression.
According to Ruge-Murcia (2002), the conditional variance was estimated by the lag of the regression output gap. Thus, this variable will explain how the lagged output gap will help predict the inflation rate in a non-linear manner. However, modeling using ARCH / GARCH is only valid in the context of time series where the output gap is conditionally heteroskedastic or changes over time.
GARCH, the Lagrange multiplier (LM test) must first be applied to determine whether the model contains an ARCH effect.
ANALYSIS AND RESULTS
- Estimation of the Conditional Mean Output Gap
- Estimation of Conditional Variance
- Stationarity Test
- Empirical Tests Estimation Results
Therefore, the conditional mean value of the output gap will be estimated using the fitted ARMA (1,1) value. Thus, this variable will explain how the output gap lag will help predict the inflation rate in a non-linear manner. In addition, the conditional variance of the output gap was estimated using a GARCH (1,1), since all ARCH-LM tests were significant, which means that the coefficient of the GARCH (1,1) model is more good.
This finding is thought to be very important for the independence status of Bank Indonesia. The test results showed that the effect of the output gap on inflation was significantly negative in the pre-independence period. In the context of monetary policy and inconsistent time preferences, with asymmetric monetary policy, the monetary authority gave greater weight to the negative output gap policy.
As a result, the asymmetric preference of the central bank would lead to increased pressure of the negative output gap in rapid inflation. The test results also showed that the effect of the output gap on inflation is nonlinear. Meanwhile, in the post-independence period of Bank Indonesia, the effect of the output gap on inflation was no longer seen, which is explained by the α coefficient that was not statistically significant.
This condition explains that committed monetary policy can cause the inflation rate to be independent of output gap pressure. According to Rogoff (1985), the degree of conservatism of the central bank can be explained by the parameters l and γ. The extent of the impact of controlled prices and volatile foodstuffs on the achievement of the inflation target for the post-independence period of Bank Indonesia recorded significant inflation for the period.
CONCLUSION
As for inflation controllable by monetary policy (core inflation), there was a clear downward trend compared to the pre-independence (pre-crisis) period. This showed that a good performance of monetary policy in the period after the independence of Bank Indonesia, and commitment to the sole purpose of achieving price stability. In the context of the empirical facts that have been presented, the effectiveness of achieving the ultimate goal of monetary policy with the sole objective of price stability will depend on the extent of Bank Indonesia's commitment to avoid time inconsistency problems in pursuing the development of low and stable inflation.
Monetary policy should be conducted more consistently with clear rules and that reduces the easing element (discretion). Monetary policy consistent with the ITF has proven to be able to reduce inflation, although the inflation target has been met satisfactorily. To further strengthen public confidence in Bank Indonesia's reputation, Bank Indonesia needs to further improve the consistency of monetary policy, which is solely aimed at achieving price stability.
Given that not all components of inflation can be affected by monetary policy (administered prices and volatile food), it is necessary to coordinate monetary policy in line with other government policies to reduce inflationary pressures from administered prices and supply constraints. Therefore, coordination between the government and Bank Indonesia must be improved to achieve the goal of price stability. Management of inflation expectations is very important in the framework of the new monetary policy (inflation targeting framework), given the magnitude of the effect of inflation expectations as a factor causing inflation.
As the prevailing pattern of formation of public inflation expectations is still backward-looking, a more transparent monetary policy is needed to reduce the information asymmetry between Bank Indonesia and economic entities.
Kim, Sokwon and Seo, Byeongseon, 2007, Nonlinear monetary policy response with asymmetric central bank preferences: some evidence for Korea. Ozlale, Umit and Ozkan Kivilcim M., 2003, Does the time inconsistency problem apply to Turkish monetary policy. Ruge-Murcia, Fransisco J., 2002, Does the Barro Gordon Model Explain the Behavior of US Inflation.
Divino, Jose A and Cajueiro, Daniel O., 2005, Inflation, Unemployment and the Time Mismatch of US Monetary Policy. Department of Economics and Finance, University of Texas Pan American Working Paper Series No.09/2007.
