Money - Inflation Nexus in Indonesia: Evidence from a P-Star Analysis
Tinbergen Institute Discussion Paper Series No. TI 05-054/4
23 Pages Posted: 6 Jun 2005
Date Written: May 2005
Abstract
In this paper the effect of excess narrow money (M1) on CPI inflation in Indonesia before, during, and after the Asian crisis is empirically examined. The standard model for the monetary analysis of inflation, i.e. the P-Star model by Hallman-Porter-Small (1991), is applied and tested empirically using quarterly Indonesian data between 1981 and 2002. The empirical model is a Markov switching error correction model. The results show that the two regime P-star model, in terms of excess M1, tracks the long run dynamics of CPI inflation in Indonesia remarkably well. Hence, there is an empirical support for the assertion that long run CPI inflation in Indonesia is a monetary phenomenon. In addition, there is evidence of a co-breaking relationship between excess M1 and consumer prices in Indonesia during the Asian crisis.
Keywords: Inflation, monetary model, structural break, regime switching error correction model, co-breaking, Asian crisis, Indonesia
JEL Classification: E31, C12
Suggested Citation: Suggested Citation
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