How Monetary Policy Works ?

The final goal of monetary policy is to preserve and maintain the stability of the rupiah, one of which is reflected in the rate of inflation low and stable. To achieve this goal by setting interest rates of Bank Indonesia BI Rate policy as the main policy instrument for influencing the activity of economic activities with the ultimate goal of achieving inflation. But the path or transmission of BI rate decision until the inflation target is very complex and takes time (time lag).

BI Rate Mechanism of the workings of the changes to affect inflation is often referred to as the transmission mechanism of monetary policy. It describes the mechanism of action of Bank Indonesia through changes in monetary instruments and operating targets affecting a variety of economic and financial variables before it finally found its way into the final destination of inflation. Mechanism occurs through the interaction between the Central Bank, the banking and financial sector, as well as the real sector. BI Rate changes affect inflation through various channels, including interest rate paths, lines of credit, exchange rate path, the path of asset prices, and expectations of the path.

In the path of interest rates, changes in the BI Rate affect deposit rates and lending rates. If the economy slows down, Bank Indonesia may use expansionary monetary policy through interest rate cuts to stimulate economic activity. Interest rate cuts BI Rate lower mortgage interest rates so that the demand for credit from firms and households will increase. Decline in lending rates will also reduce the cost of capital for investment. This all will increase consumption and investment activity so that economic activity was getting excited. Conversely, if inflation increases pressure, Bank Indonesia responded by raising interest rates for the BI Rate halt economic activity too quickly, thereby reducing inflationary pressures.

BI Rate changes also can affect exchange rates. This mechanism is often called the exchange rate. Increase in the BI Rate, for example, will push up the difference between interest rates in Indonesia with interest rates abroad. With the widening of the difference in interest rates is encouraging foreign investors to invest in financial instruments in Indonesia such as the SBI because they will get a higher rate of return. Foreign capital inflows which in turn will encourage the appreciation of the rupiah exchange rate. Currency appreciation resulting in cheaper prices of imported goods and export goods abroad become more expensive or less competitive so that it will encourage imports and reduce exports. The fall in net exports will have an impact on economic growth and declining economic activity.

BI Rate changes affect the macro economy through changes in asset prices. The increase in interest rates will lower the price of assets such as stocks and bonds, thus reducing the wealth of individuals and companies which in turn reduces their ability to engage in economic activities such as consumption and investment.

The impact of interest rate changes on economic activity also affect public expectations of inflation (expected path). Decline in interest rates that are expected to encourage economic activity and inflation ultimately encourage workers to anticipate rising inflation by requiring higher wages. Wages will eventually be charged by producers to consumers through higher prices.

Transmission mechanism of monetary policy works need time (time lag). Time lag of each path can be different from the others. Exchange pathways usually work faster because the impact of interest rate changes to work very fast rate. Banking and financial sector conditions are also very influential on the speed of monetary policy tarnsmisi. If the banks see a high enough risk of the economy, the response of banks to interest rate cuts BI rate is usually very slow. Also, if the banks are doing to improve the consolidation of capital, reduction in loan interest rates and rising credit demand is not necessarily respond by increasing lending. On the demand side, the decline in bank lending rates have not necessarily responded by rising credit demand from the public if the prospects of the economy is sluggish.

Conclusion :

The condition of the financial sector, banking and real sector conditions are very effective role in determining whether or not the transmission of monetary policy. Decline in interest rates should not diminish the quality of banking. Bank Indonesia has so far been taking steps in a positive and open space Encouraging lending rate to fall, from the nature of persuasion to concrete steps lower the BI Rate.

The central bank also expanded the boundaries of special facilities BI by 50 bps to 200 bps from the BI Rate. However, the decline in bank interest rates on a range of dimensions, and in need of restructuring. We are sorry if there are flaws in this article, I really expect critics and constructive suggestions from readers. Thank you.