The purpose of this thesis is to analyse Bank Indonesia (BI)’s credibility as the Indonesian central bank. BI became an independent central bank in the aftermath of 1998 Asian Financial Crisis (AFC), and after a brief period of ambiguity, adopted inflation-targeting framework in July 2005. This study investigates the empirical evidence of BI’s credibility under inflation targeting. The hypothesis is there is negative relationship between interest rate changes and credibility. In other words, there are fewer changes in interest rate when credibility is high. In addition, the costs of disinflation is lower when credibility is high.
The methodology is similar with the one applied by Nahon and Meurer (2009) in their study of the Brazilian central bank. The data is the monthly credibility indexes, the BI rate (interbank rate target), and the interbank rate (observed interbank rate). The sample is from July 2005 to December 2013. To check the stationarity of the data, Augmented Dickey-Fuller (ADF) and Phillips-Perron (PP) tests were employed. Using Granger causality test, the relationship between credibility indexes and both rates were measured. Using the Ordinary Least Square (OLS) method, a regression analysis between credibility indexes and BI rate changes were determined.
This study shows that BI had lost its credibility in the early years of inflation targeting (2005-2008), but gradually improving since 2009. It is reflected by fewer changes in monthly BI rate target announcements, smoother interbank rate movement, and more controlled inflation. It is very likely that BI is projecting downward trend of inflation and establishing its credibility by making a track record of fighting inflation.