Linking monetary and macroprudential policies in the presence of external shocks: the case of Indonesia.

Abstract

The limited experience of practising monetary and macroprudential policies at the same time raises a question about the extent to which a macroprudential instrument - as a complement to monetary policy - affects the macroeconomic stabilisation in emerging markets, particularly in the presence of external shocks. By performing a systematic review of 125 articles, this thesis provides novel and insightful evidence on the interaction between monetary and macroprudential policies in emerging markets by refining what we already know on the extant relationship. It also provides a comprehensive synthesis of the theoretical arguments on the interaction between the two policy expedients. For the first time, we incorporate in our analysis the impact of policies embodied in the payment system - such as the limitation of the value that can be settled through large-value payment systems - hence making new inroads in the respective empirical literature. Further, it makes evident that a shift from currency - to electronic -based payments supports financial intermediation. In addition to that, the study draws insights from the benefits of FX intervention as an instrument in an emerging market that implements an inflation targeting framework. Not only do we model the risk appetite of investors as a shock to the economy but we also take into account households with limited financial access. As a result, it is demonstrated that FX intervention can be employed by policymakers to stabilise an economy during a period of capital flow shocks. Finally, this thesis advances our knowledge by developing a framework - in the emerging market context - to analyse the impact of using reserve requirements combined with FX intervention as key instruments in an inflation-targeting framework. It suggests that reserve requirement can be utilised by policy makers to complement interest rate policy and FX intervention in stabilising the economy during a period of external shocks, particularly a risk appetite shock.