Monetary Policy in Indonesia: Dynamics of Inflation, Credibility Index and Output Stability Post Covid 19: New Keynesian Small Macroeconomics Approach

Abstract

This study uses the new Keynesian small macroeconomics approach to investigate how the inflation dynamics, level of credibility, and output stability influence the reaction function of the monetary authority. This study utilizes time series data from January 2021 through April 2022. The developed estimation model is based on the New Keynesian Small Macroeconomics model when examining the reaction function of monetary policy in Indonesia using the 3SLS Model estimation. The nominal interest rate is the primary instrument of the central bank's reaction function, which expressly incorporates the credibility index of the monetary policy included in the expected inflation model. The study results indicate that the credibility index of monetary policy converges with macroeconomic variables with an average credibility index, meaning that economic agents have a high degree of credibility with Bank Indonesia's monetary policy. Aspects of aggregate demand, the central bank's policy to stabilize prices through nominal interest rates that directly affect aggregate demand, and from the perspective of aggregate supply as a proxy, the new Keynesian Phillips curve model demonstrates that the model coefficient is significantly different from zero in situations where changes in demand are not immediately responsive to price increases.