Does the Credible Fiscal Policy Support the Prices Stabilization?

Open access


This paper aims at analyzing the co-movement between fiscal policy and monetary policy rules in the context of price stabilization. More specifically, we observe the potential impact of fiscal policy credibility on the price stabilization in the inflation targeting framework. Motivated by the fact that empirical studies concerning this aspect are still limited, we take the case of Indonesia over the period 2001-2013. Based on the quarterly data analysis, we found that the impact of credibility typically depends on characteristics of fiscal rules commitment. On one hand, the credibility of debt rule reduces the inflation rate. In contrast, the incredible deficit rule policy does not have any impact on the inflation rate and therefore does not support to inflation targeting. Given those results, we conclude that credibility matters in stabilizing price levels. Accordingly, those findings suggest tightening coordination between monetary and fiscal policy to maintain fiscal sustainability in accordance with price stabilization policy

ABDUROHMAN. (2013). The Behavior of Fiscal Policy in Indonesia in Response to Economic Cycle: A Comparison with other ASEAN Countries. Paper presented in the 23rd PRSCO and the 4th IRSA Institute, July, 2-4, Bandung.

ABO-ZAID, S. and TÜZEMEN, D. (2012). Inflation Targeting: A Three-Decade Perspective. Journal of Policy Modeling, 34(5). pp. 621-45.

AFONSO, A., AGNELLO, L., and FURCERI, D. (2010). Fiscal Policy Responsiveness, Persistence, and Discretion. Public Choice, 145(3). pp. 503-30.

AIZENMAN, J. and MARION, N. (1993). Policy Uncertainty, Persistence, and Growth. Review of International Economics, 1(2). pp. 145-63.

AKITOBY, B. et al. (2006). Public Spending, Voracity, and Wagner's Law in Developing Countries. European Journal of Political Economy, 22(4). pp. 908-24.

ARTHA, I.K.D.S. (2007). Interaction of Monetary and Fiscal Policy in Developing Countries. Unpublished Thesis, Faculty of Economics, University of Indonesia, Jakarta.

ASIAN DEVELOPMENT BANK. (2010). Asian Development Outlook, Part 2, Macroeconomic Management beyond the Crisis. Asian Development Bank, Manila.

BARRO, R.J. (1974). Are Government Bonds Net Wealth? Journal of Political Economy, 82(6). pp. 1095-117.

BARRO, R.J. and GORDON, D.B. (1983). Rules, Discretion, and Reputation in a Model of Monetary Policy. Journal of Monetary Economics, 12(1). pp. 101-21.

BAXTER, M. (1985). The Role of Expectations in Stabilization Policy, Journal of Monetary Economics, 15, pp. 343-62.

BLANCHARD, O. and PEROTTI, R. (2002). An Empirical Characterization of the Dynamic Effects of Changes in Government Spending and Taxes on Output. Quarterly Journal of Economics, 117(4), November. pp. 1329-68.

BLINDER, A. (2004). The Case against the Case against Discretionary Fiscal Policy. Center for Economic Policy Studies, Princeton University, June.

BLÖNDAL, J.R., HAWKESWORTH, I., and CHOI, H. (2009). Budgeting in Indonesia. OECD Journal on Budgeting, 2009/2.

BOVA, E., CARCENAC, N. and GUERGUIL, M. (2014). Fiscal Rules and the Procyclicality of Fiscal Policy in the Developing World, IMF Working Paper, WP/14/122, July.

CANZONERI, M.B., CUMBY, R.E., and DIBA. B.T., (2002). Should the European Central Bank and the Federal Reserve be Concerned about Fiscal Policy? Proceeding of a Conference on Rethinking Stabilization Policy, Federal Reserve Bank of Kansas City, Jackson Hole. pp. 333-89.

CLARK, C.S. (2011). What is 'Credible' Fiscal Policy? The Canadian Experience, 1983-2010: The View of a Former Practitioner, in New Directions for Intelligent Government in Canada: Papers in Honor of Ian Stewart, Centre for the Study of Living Standards, pp. 101-26.

COCHRANE, J. (1998). A Frictionless View of US Inflation. In B. Bernake and J. Rotemberg. (eds), NBER Macroeconomics Annual. pp. 323-84.

COCHRANE, J. (2001). Long Term Debt and Optimal Policy in the Fiscal Theory of the Price Level. Econometrica, 69(1). pp. 69-116.

COMBES, J., DEBRUN, X., MINEA, A., and TAPSOBA, R. (2014). Inflation Targeting and Fiscal Rules: Do Interactions and Sequencing Matter? IMF Working Paper WP/14/89, May.

DE BROUWER, G.J., RAMAYANDI, A., and TURVEY, D. (2006). Macroeconomic Linkages and Regional Monetary Cooperation: Steps Ahead. Asian Economic Policy Review, 1(2). pp. 284-301.

FATÁS, A. and MIHOV, I. (2003). The Case for Restricting Fiscal Policy Discretion. Quarterly Journal of Economics, 118(4). pp. 1419-47.

FATÁS, A. and MIHOV, I. (2006). The Macroeconomic Effects of Fiscal Rules in the US States. Journal of Public Economics, 90(1-2). pp. 101-17.

FREEDMAN, C. and ÖTKER-ROBE, I. (2010). Important Elements Inflation Targeting for Emerging Economies. IMF Working Paper, WP10-113.

GALÍ, J. (1994). Government Size and Macroeconomic Stability. European Economic Review, 38, January. pp. 117-32.

GILL, H. (2011). State of the Art of Inflation Targeting. Centre for Central Banking Studies Handbook No. 29, London: Bank of England.

HAUNER, D., JONÁŠ, J. and KUMAR, M.S. (2007). Policy Credibility and Sovereign Credit: the Case of the new EU Member States, IMF Working Paper WP07/1.

HERMAWAN, D. and MUNRO, A. (2008). Monetary-Fiscal Interaction in Indonesia. BIS Working Paper, January, draft.

HSING, Y. (2008). Is the Monetary Policy Rule Responsive to Exchange Rate Changes? The case of Indonesia, Malaysia, the Philippines, and Thailand. International Review of Economics, 56(2). pp. 123-32.

HUR, S., MALLICK, S., and PARK, D. (2010). Fiscal Policy and Crowding Out in Developing Asia. ADB Economics Working Paper Series, No. 222, September.

IMF. (2013). Fiscal Rules Dataset 1985-2013. IMF Fiscal Affairs Department, September.

JUHRO, S.M. (2008). The Optimal Monetary Policy Response in Indonesia: The State- Contingent Rule? Bulletin of Monetary Economics and Banking, 10(4), April. pp. 303-36.

KADRIA, M. and BEN-AISSA, M.S. (2014). Implementation of Inflation Targeting and Budget Deficit Performance in Emerging Countries: A Treatment Effect Evaluation. Journal of Applied Business Research, 30(4). pp. 1077-90.

KOPITS, G. (2001). Fiscal Rules: Useful Policy Framework or Unnecessary Ornaments? IMF Working Paper, WP/01/145.

KUNCORO, H. and SEBAYANG, K.D.A. (2013). The Dynamic Interaction between Monetary and Fiscal Policies in Indonesia. Romanian Journal of Fiscal Policy, 4(6), January-June. pp. 47-66

KYDLAND, F.E. and PRESCOTT, E.C. (1977). Rules Rather than Discretion: The Inconsistency of Optimal Plans. Journal of Political Economy, 85(1). pp. 473-91.

LANE, P.R. (2003). The Cyclical Behavior of Fiscal Policy: Evidence from the OECD. Journal of Public Economics, 87(12). pp. 2661-75.

LEEPER, E.M. (1991). Equilibria under ‘Active’ and ‘Passive’ Monetary and Fiscal Policies. Journal of Monetary Economics, 27(1), February. pp. 129-47.

LUCOTTE, Y. (2012). Adoption of Inflation Targeting and Tax Revenue Performance in Emerging Market Economies: An Empirical Investigation. Economic Systems, 36(4). pp. 609-28.

MIHALJEK, D. (2009). The Financial Turmoil in Central and Eastern Europe and Fiscal Policy in Croatia. Occasional publication of Institute of Public Finance, No.40, May 2009.

MINEA, A. and TAPSOBA, R. (2014). Does Inflation Targeting Improve Fiscal Discipline? Journal of International Money and Finance, 40. pp. 185-203.

MINEA, A., TAPSOBA, R., and VILLIEU, P. (2012). Can Inflation Targeting Promote Institutional Quality in Developing Countries? University of Orleans, mimeo.

MINEA, A. and VILLIEU, P. (2010). Financial Development, Institutional Quality, and Maximizing-Growth Trade-Off in Government Finance. Economic Modelling, 27(1), January. pp. 324-35.

MOCHTAR, F. (2004). Fiscal and Monetary Policy Interaction: Evidences and Implication for Inflation Targeting in Indonesia. Bulletin of Monetary Economics and Banking, 7(3), December. pp. 359-86.

NAERT, F. (2011). Credibility of Fiscal Policies and Independent Fiscal Bodies. Review of Business and Economic Literature, 56(3). pp. 288-309. RAMAYANDI, A. (2007). Approximating Monetary Policy: Case Study for the ASEAN-5. Working Papers in Economics and Development Studies (WoPEDS) 200707.

RIYANDI, G. (2012). Meta-Analysis of Money Demand in Indonesia. Bulletin of Monetary Economics and Banking, 15(1), July. pp. 41-61.

ROGER, S. (2009). Inflation Targeting at 20: Achievements and Challenges. IMF Working Paper, WP09-236.

ROGOFF, K.S. (2008). Inflation Is Now the Lesser Evil. Project Syndicate, December,

ROTHER, P.C. (2004). Fiscal Policy and Inflation Volatility. European Central Bank Working Paper, No. 317.

SACCHI, A. and SALOTTI, S. (2014). The Impact of National Fiscal Rules on the Stabilization Function of Fiscal Policy. MPRA Working Paper No. 56982, University Library of Munich, Germany.

SARGENT, T.J. and WALLACE, N. (1981). Some Unpleasant Monetarist Arithmetic. Federal Reserve Bank of Minneapolis Quarterly Review, 5. pp. 1-17.

SCOTT, R. (2010). Inflation Targeting Turns 20. Finance & Development, 47(1). pp. 46-9.

SIMS, C. (1994). A Simple Model for Study of the Price Level and the Interaction of Monetary and Fiscal Policy. Economic Theory, 4. pp. 381-99.

SIMS, C. (2004). Limits to Inflation Targeting. In B.S. Bernanke and M. Woodford. (Edt), The Inflation-Targeting Debate, NBER University of Chicago Press. pp. 283-309.

SNYDER, W. (1985). The Budget Impact on Economic Growth and Stability in Indonesia. Ekonomi dan Keuangan Indonesia, 33(2), July. pp. 21-34.

STOIAN, A. (2012). How Vulnerable is Fiscal Policy in Central and Eastern European Countries? Romanian Journal of Fiscal Policy, 3(2), July-December, pp. 68-81.

TANG, H.C., LIU, P., and CHEUNG, E.C. (2010). Changing Impact of Fiscal Policy on Selected ASEAN Countries. ADB Working Paper Series on Regional Economic Integration No. 70, December.

WIMANDA, E.R., TURNER, P.M., and HALL, M.J.B. (2011). Expectations and the Inertia of Inflation: The Case of Indonesia. Journal of Policy Modeling, 33(3). pp. 426-38.

WOODFORD, M. (1994). Monetary Policy and Price Level Determinacy in a Cash-in- Advance Economy. Economic Theory, 4. pp. 345-80.

WOODFORD, M. (1998). Doing without Money: Controlling Inflation in a Post- Monetary World. Review of Economic Dynamics, 1. pp. 173-219.

Review of Economic Perspectives

Národohospodárský obzor; The Journal of Masaryk University

Journal Information

CiteScore 2018: 0.66

SCImago Journal Rank (SJR) 2018: 0.21
Source Normalized Impact per Paper (SNIP) 2018: 0.682


All Time Past Year Past 30 Days
Abstract Views 0 0 0
Full Text Views 392 229 13
PDF Downloads 161 110 8