Factors Affecting Real Exchange Rates (RER) In Indonesia 2000-2017

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Introduction

The real exchange rate (RER) is a crucial indicator of a country's economic performance, as it reflects the purchasing power of its currency relative to other currencies. In Indonesia, the RER has been a subject of interest for policymakers, investors, and researchers due to its significant impact on the country's economic stability and growth. This study aims to analyze the effect of several key variables on the RER of the Indonesian rupiah against the US dollar from 2000 to 2017. The variables examined include the BI Rate, Nominal GDP, and Wholesale Price Index (WPI) of the United States.

Literature Review

The real exchange rate is influenced by various factors, including monetary and fiscal policies, economic indicators, and global economic conditions. The BI Rate, set by Bank Indonesia, is a key monetary policy tool that affects the interest rate and, subsequently, the exchange rate. Nominal GDP, which reflects a country's economic growth, is also a significant factor in determining the RER. The WPI of the United States, which measures the price of goods at the wholesale level, can also impact the RER, particularly in the context of trade and inflation policies.

Methodology

This study employs a quantitative approach, using secondary data from economic indicators such as the Consumer Price Index (CPI) of Indonesia, the nominal exchange rate of the rupiah per USD, the US CPI, the BI Rate, and the nominal GDP of Indonesia. The data used is quarterly for a predetermined period from 2000 to 2017. The analysis method chosen is the Error Correction Model (ECM), which allows researchers to understand the short-term and long-term relationships between these variables.

Research Result

The results of this study show that simultaneously, the BI Rate, Nominal GDP, and WPI USA variables have a significant effect on the real exchange rate (RER) at a 95% confidence level. This influence is clearly seen in the long run, but it is not proven significant in the short term.

BI Rate

There is a significant positive influence of the BI Rate on the real exchange rate (RER) both in the long and short term. This indicates that the interest rate set by Bank Indonesia plays an important role in strengthening the rupiah exchange rate. When the BI Rate increases, it often creates an attraction for foreign investors, which in turn increases demand for the rupiah.

Nominal GDP

Nominal GDP shows a significant positive effect on RER in the long run. This shows that Indonesia's higher economic growth correlates with the strengthening of the rupiah exchange rate. However, in the short term, the impact is positive but insignificant. This can be caused by economic fluctuations that occur in depth in the short term.

USA WPI

WPI, which refers to the wholesale price index in the United States, shows a significant negative effect on the real exchange rate (RER) in the long run. On the other hand, the effect in the short term is also negative but not significant. This shows that when the price of goods at the wholesale level in the US increases, it has the potential to weaken the rupiah, especially if it is not balanced with economic growth in Indonesia.

Additional Analysis and Explanation

This study provides important insights for policymakers and market participants regarding the factors that affect the exchange rate in Indonesia. In the context of monetary policy, an understanding of how the BI Rate can affect the RER can be a reference for decision making in establishing interest rates. In addition, healthy GDP growth is a good indicator for strengthening exchange rates, which shows the need to focus on increasing productivity and investment in strategic sectors.

In the case of WPI, although there is a negative influence in the long run, this can also be used as an indicator to monitor the global economic conditions, especially related to trade and inflation policies in the US. It is essential for Indonesia to prepare a mitigation strategy on this negative impact, such as increasing export diversification or domestic inflation control.

Conclusion

Overall, this research confirms the importance of continuous supervision of the factors that affect the exchange rate to ensure long-term economic stability. The application of the right policy based on the results of this analysis will help increase the competitiveness of the rupiah and ensure sustainable economic growth in Indonesia.

Policy Implications

The findings of this study have significant policy implications for Indonesia. Firstly, the BI Rate should be set in a way that balances the need to attract foreign investment with the need to maintain economic stability. Secondly, policymakers should focus on increasing productivity and investment in strategic sectors to achieve healthy GDP growth. Finally, Indonesia should prepare a mitigation strategy to address the negative impact of the WPI on the RER.

Limitations and Future Research Directions

This study has several limitations, including the use of secondary data and the focus on a specific period. Future research should aim to address these limitations by using primary data and examining a longer period. Additionally, future research should explore other factors that affect the RER, such as trade policies and global economic conditions.

References

  • Bank Indonesia. (2017). Annual Report 2017.
  • Central Bureau of Statistics. (2017). Indonesia in Figures 2017.
  • International Monetary Fund. (2017). World Economic Outlook 2017.
  • World Bank. (2017). World Development Indicators 2017.

Q: What is the real exchange rate (RER) and why is it important?

A: The real exchange rate (RER) is a measure of the purchasing power of a country's currency relative to other currencies. It is an important indicator of a country's economic performance and stability. A strong RER can indicate a country's economic growth and competitiveness, while a weak RER can indicate economic instability and potential devaluation.

Q: What are the key factors that affect the RER in Indonesia?

A: The key factors that affect the RER in Indonesia include the BI Rate, Nominal GDP, and Wholesale Price Index (WPI) of the United States. These factors can influence the RER in both the short and long term.

Q: How does the BI Rate affect the RER in Indonesia?

A: The BI Rate has a significant positive influence on the RER in Indonesia. When the BI Rate increases, it often creates an attraction for foreign investors, which in turn increases demand for the rupiah. This can strengthen the RER and improve Indonesia's economic stability.

Q: How does Nominal GDP affect the RER in Indonesia?

A: Nominal GDP has a significant positive effect on the RER in Indonesia. Healthy GDP growth can indicate a country's economic growth and competitiveness, which can strengthen the RER. However, in the short term, the impact of Nominal GDP on the RER may be positive but insignificant due to economic fluctuations.

Q: How does the WPI of the United States affect the RER in Indonesia?

A: The WPI of the United States has a significant negative effect on the RER in Indonesia. When the price of goods at the wholesale level in the US increases, it can weaken the rupiah and potentially lead to devaluation. This can have a negative impact on Indonesia's economic stability and growth.

Q: What are the policy implications of this study?

A: The findings of this study have significant policy implications for Indonesia. Policymakers should focus on setting the BI Rate in a way that balances the need to attract foreign investment with the need to maintain economic stability. Additionally, policymakers should focus on increasing productivity and investment in strategic sectors to achieve healthy GDP growth.

Q: What are the limitations of this study?

A: This study has several limitations, including the use of secondary data and the focus on a specific period. Future research should aim to address these limitations by using primary data and examining a longer period. Additionally, future research should explore other factors that affect the RER, such as trade policies and global economic conditions.

Q: What are the future research directions?

A: Future research should aim to explore other factors that affect the RER, such as trade policies and global economic conditions. Additionally, future research should examine the impact of the RER on Indonesia's economic growth and stability.

Q: What are the practical implications of this study?

A: The findings of this study have practical implications for policymakers, investors, and market participants. Policymakers should use the results of this study to inform their decision-making on monetary policy and economic development. Investors and market participants should also take into account the factors that affect the RER when making investment decisions.

Q: What are the contributions of this study?

A: This study contributes to the existing literature on the factors that affect the RER in Indonesia. It provides new insights into the impact of the BI Rate, Nominal GDP, and WPI of the United States on the RER. Additionally, it provides practical implications for policymakers, investors, and market participants.

Q: What are the future challenges?

A: The future challenges for Indonesia include maintaining economic stability and growth in the face of global economic uncertainty. Policymakers should continue to monitor the factors that affect the RER and adjust their policies accordingly. Additionally, policymakers should focus on increasing productivity and investment in strategic sectors to achieve healthy GDP growth.