1. PUBPOL 542: Indonesia Presentation Indonesia 2000-2006: Walking the Fiscal and Monetary Policy Tightrope Jonathan Haney, David Kase, Vishaal Rana Public Policy 542

2. PUBPOL 542: Indonesia Presentation Executive Summary Since the Asian financial crisis, Indonesia has made numerous economic strides including paying off its IMF debt and regaining GDP growth Indonesia’s macroeconomic indicators suggest inflation, unemployment, and interest rates are high Indonesia is highly dependent on oil exports, which can skew its macroeconomic data and adds risk to policy recommendations Primary economic challenges for the country are: 1) Increasing GDP Growth 2) Reducing Inflation 3) Increasing income and service accounts in Current Account The team recommends lowering taxes to stimulate growth and employment and tightening the money supply to reduce inflation

3. PUBPOL 542: Indonesia Presentation Macroeconomic Overview: Key Indicators 20022003200420052006 2007 Target Real GDP Growth 4.4%4.7%5.1%5.6%6.2%6.0% Inflation Rate10.0%6.8%6.1%10.5%13.2%6.2% Unemployment Rate 9.1%9.6%9.9%10.3%12.6%N/A Current Account 109,145(5,397)21,832112,164Positive Slightly Positive Interest Rate----9.75%8.0-8.5%

4. PUBPOL 542: Indonesia Presentation Macroeconomic Overview: Selected Comparable Indicators 20022003200420052006 Real GDP Growth Indonesia4.4%4.7%5.1%5.6%6.2% ASEAN4.8%5.4%6.1%5.6%5.8% Inflation Rate Indonesia10.0%6.8%6.1%10.5%13.2% ASEAN7.3%5.1%4.8%7.4%8.1% Interest Rate Indonesia13.6%7.1%6.7%11.8%9.7% ASEAN5.7%5.3%5.0%5.7%4.2% Note: Interest Rate is 3 month time deposit Source: ASEAN

5. PUBPOL 542: Indonesia Presentation Macroeconomic Overview: Government Spending and Tax Collection Government is moving towards a balanced budget High military spending compared to social services Tax recovery rate has accelerated since financial crisis, but still below historical Taxes as Percentage of Government Revenue Revenues vs Expenditures

6. PUBPOL 542: Indonesia Presentation Major Issues in Indonesian Economy GDP Growth  High unemployment is limiting the economy from operating at full employment  Recent GDP growth may be artificially buoyed by high oil prices Inflation  While central bank has mandated inflation control, money supply has grown faster than inflation  Inflation expectations thus remain high Current Account  Despite surplus, significant deficit in income and service accounts  Mineral (oil) exports prop CA and key trading partner is Japan

7. PUBPOL 542: Indonesia Presentation Zones of Discomfort S (IDR/USD) Fiscal Ease (G↑ or T↓) CA is slightly negative (~500MM USD) Economy is at full employment Indonesia Excessive CA surplus Underemployment ● Economic Production Unemployment is currently at 12.6% Underemployment is expected to be significantly higher 17% are living below the poverty line Current Account Given their developing economy, CA should be negative However, Indonesia has a surplus and needs to plow that surplus back into economic growth

8. PUBPOL 542: Indonesia Presentation Output Market Equilibrium (DD schedule) Aggregate Demand (D) Output (Y) D = Y Many avenues exist to drive up output; we choose tax rate decrease because: Encourages growth by internal resources to meet additional demand Entices other foreign direct investment to come into Indonesia We do not expect a significant price increase to result The country is operating below full employment, so wages shouldn’t increase (t=12%) (t=11%) Y0Y0 Y1Y1

9. PUBPOL 542: Indonesia Presentation Current Asset Market Equilibrium (AA schedule) Exchange Rate (S) Dom Interest Rate (i) Currently the real money supply is growing Between 2000 & 2005, the money supply has grown by 74% and inflation has grown by 55% This causes the exchange rate to “overshoot,” creating a much larger depreciation of Rupiah The resulting reduction in exchange rate hasn’t occurred because the economy hasn’t returned to steady state or seen real money supply contraction Real Domestic Money Holdings (M S /P) S0S0 S1S1 S2S2 Interest rate parity curve shifts outward due to expected inflation

10. PUBPOL 542: Indonesia Presentation Proposed Asset Market Equilibrium (AA schedule) Exchange Rate (S) Dom Interest Rate (i) Our recommended steps work to pull down the real money supply. As currency dries up, inflation will be put under pressure to reduce as the money supply contracts Again, the currency will see a high initial appreciation followed by depreciation as prices adjust Our concern is the effects that a tighten monetary policy will have on output (Y) Real Domestic Money Holdings (M S /P) S0S0 S1S1 S2S2 Interest rate parity curve shifts inward due to expected appreciation S1S1 S2S2

11. PUBPOL 542: Indonesia Presentation Recommended Action Steps AA-DD Curve Our action plan is a series of steps 1. Grow the economy through fiscal policy action (e.g., tax rate decrease) Currency appreciates Output increases 2. Tighten monetary supply through a real money supply contraction Output decreases Currency appreciates 3. Repeat the process Strategy will have to change once country reaches full employment Exchange Rate (S) Output (Y) DD 0 AA 0 Y0Y0 S0S0 DD 1 Y1Y1 Y2Y2 AA 2 DD 3 Y3Y3 YfYf

12. PUBPOL 542: Indonesia Presentation Questions?