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DOES INFLATIONAFFECT ECONOMICGROWTH? Therelevance of the debatefor IndonesiaAnis ChowdhuryPublished online: 13 Dec 2010.

To cite this article: Anis Chowdhury (2002): DOES INFLATION AFFECTECONOMIC GROWTH? The relevance of the debate for Indonesia, Journalof the Asia Pacific Economy, 7:1, 20-34

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D O E S I N F L A T IO N A F F E C T E C O N O M I C

G R O W T H ?

The relevance of the debate for Indonesia

Anis Chowdhury

Abstract This research was motivated by the current constraints on macro-economic policy-making in Indonesia. On the � scal side, the government isburdened with debt and the pressure to maintain social expenditure. On themonetary side, there is a preoccupation with a lower in� ation rate and theneed to maintain liquidity in a depressed economy. By examining the in� a-tion–growth relationship, this study examines whether there is any room forin� ating the economy. This would ease the pressure on government debtrepayment while maintaining social expenditure, and the economic recoverywould not be stalled by prematurely tightening monetary policy. The study� nds that there is no statistically signi� cant relationship between in� ation andgrowth, and argues for a more expansionary macroeconomic policy mix. Italso argues that the conditions for an independent central bank do not existin Indonesia, and such an institutional arrangement is premature whenmechanisms for democratic oversight are not yet in place.

Keywords In� ation, economic growth, central bank independence.

JEL classi� cations E31, E59, E65, O47.

Is in� ation harmful to growth? The ratio of fervent beliefs to tangibleevidence seems unusually high on this topic.

(Bruno and Easterly 1998: 3)

1 . IN T RO D U CT IO N

With origins in the 1950s’ Latin American context, the question of therelationship between in� ation and economic growth generated an endur-ing debate between ‘structuralists’ and ‘monetarists’.1 Structuralists believethat in� ation accompanies economic growth, whereas monetarists see

Journal of the Asia Paci�c Economy 7(1) 2002: 20–34© 2002 Taylor & Francis Ltd

ISSN 1354–7860 print/ISSN 1469–9648 onlineDOI: 10.1080/13547860120110452

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in� ation as detrimental to economic progress. As Bruno and Easterly(1998) observed, there are more passions than facts in this debate.

The debate is particularly relevant for Indonesia given the nation’s his-torical experience. The Indonesian economy virtually came to a halt in the1960s and the average annual in� ation rate peaked at 1,500 per cent in mid-1966. At the time pessimism about the prospects of the Indonesianeconomy was widespread.2 The coincidence of extremely high rates of in� a-tion with economic stagnation was powerful evidence for casting in� ationas ‘enemy number one’. The New Order regime and its economic advisershad no doubts on this issue.3 Thus, top priority was given to price stability.By 1969 the annual average in� ation rate was successfully lowered toaround 15 per cent and remained effectively under control. This providedthe foundation for a period of sustained and rapid economic growth.Following the � rst oil price shock, in� ation rose to 41 per cent in 1974, butthe economic management team was successful in bringing down this� gure to less than 20 per cent. Following the 1997 crisis, the credibility ofBank Indonesia (BI) in controlling in� ation has been enhanced after in� a-tion was brought down to around 12 per cent within a year from its peak ofnearly 130 per cent.

Thus it seems that in Indonesia there is strong in� ation aversion, whichis the product of this nation’s historical experience. However, this per-spective poses a problem, particularly when economic recovery remainsfragile. Experts such as Paul Krugman, Hubert Neiss and Philip Browninghave expressed concerns that preoccupation with a set target could pushBI to prematurely tighten the monetary screws and threaten the nascenteconomic recovery.4 The policy dilemma was acknowledged by BI (2000:7) itself when it observed:

. . . policy dilemma [emphasis in original] in the monetary decision-making process at Bank Indonesia. On the one hand, if the policy istightly directed at attaining in� ation target and exchange rate stab-ility, it is feared to disturb the current economic recovery [emphasisadded]. . . on the other hand, monetary policy that tends to be accom-modative will create higher in� ation expectations.5

In light of the above, this article attempts to place the policy dilemmawithin the broader context of the in� ation debate. It begins with a briefoverview of both theoretical and empirical literature to examine whetherthere is any scope for a ‘moderate in� ation rate’, above what is currentlytargeted. In other words, this study seeks to answer:

(a) What is the potential gain in allowing the in� ation rate to rise to amoderate level (say, 13–15 per cent)?

(b) What is the risk of in� ation going out of hand, and eventually affectingeconomic growth adversely?

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(c) What are the implications of central bank independence during thecurrent democratic transition?

2 . T H E O R Y AN D E VID E N CE

Does in� ation negatively affect economic growth? Theoretically, the answeris both yes and no. Some economists, mainly of Keynesian persuasion,believe that in� ation contributes positively to economic growth through anumber of channels.

1 Redistribution of income in favour of pro� t earners with high savingspropensity (Keynes–Kaldor effect).

2 Changes in the portfolio of investment from the � nancial sector to thereal sector as the real returns from � nancial investment decline. Thisraises capital intensity (Tobin effect).

3 Serving as a necessary lubricant for the wheels of the economy (Tobineffect). This implies that in� ation is an unavoidable part of economicgrowth.

4 Forced savings through increased seigniorage or in� ation tax as peoplehave to hold more money to maintain the real value of savings. Thistransfers resources to the government to be used for investment (Kaleckieffect).

Other economists, mainly of the neoclassical school, believe that in� a-tion affects economic growth negatively, for the following reasons:

1 In� ation causes uncertainty about the future earning stream and henceadversely affects investment.

2 A high rate of in� ation leads to high variability of in� ation that gives con-fusing signals to economic agents. This, in turn, leads to lower investmentand hence growth.

3 Since different sectoral prices rise at different rates, in� ation causes dis-tortion in investment decisions, and hence misallocation of resources.

4 Since in� ation reduces the real value of � nancial assets, it encouragespeople to save in real assets such as precious metals or real estate. Thisadversely affects � nancial deepening.

5 In� ation causes real appreciation of domestic currency and henceadversely affects exports.

What is the evidence for either side of the in� ation debate? Let us beginwith the following observation by Friedman (1973: 41): ‘Historically, allpossible combinations have occurred: in� ation with and without [econ-omic] development, no in� ation with and without [economic] develop-ment’. Thus, there are two aspects to this debate: (a) the nature of therelationship, if one exists; and (b) the direction of causality.

Earlier works (e.g., Tun Wai 1959; Bhatia 1960–61) failed to establish any

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meaningful relationship between in� ation and economic growth. Examin-ation by Paul et al. (1997) involving seventy countries (of which forty-eightare developing economies) for the period 1960–89 found no causal relationbetween in� ation and economic growth in 40 per cent of countries; theauthors reported bidirectional causality in about 20 per cent of countriesand unidirectional (either in� ation to growth or vice versa) relationshipsin the rest. Of greater interest, the relationship was found to be positive insome cases, but negative in others.

Recent cross-country studies that found in� ation negatively affectingeconomic growth include Fischer (1993), Barro (1996) and Bruno andEasterly (1998). The studies by Fischer and by Barro found in� ation had avery small negative impact on growth. Fischer (1993) found that a 10 per-centage point rise in in� ation (from 5 per cent to 15 per cent) is correlatedwith a decline in output growth of only 0.4 per cent per annum. SimilarlyBarro (1996) estimated that 1 per cent extra in� ation reduces economicgrowth by between 0.02 and 0.03 per cent per annum. Yet Fischer (1994:281) concluded: ‘. . . however weak the evidence, one strong conclusion canbe drawn: in� ation is not good for longer-term growth’. And Barro (1996:159) asserts, ‘. . . the magnitude of effects are not that large, but are morethan enough to justify a keen interest in price stability’.

A similar shaky attempt can also be found in Anderson and Gruen’s(1995: 302) justi� cation of the Reserve Bank of Australia’s low-in� ationmonetary strategy, as re� ected in the following quote:

The estimated coef�cient on in� ation is negative for all thirty regres-sions. . . . In about half the regressions, this negative estimate is sta-tistically signi� cant at a 5 per cent level, while in the other half, it isstatistically insigni� cant. Average in� ation is, therefore, a fragileexplanation of economic growth.

Yet Anderson and Gruen (1995: 303) go on to claim: ‘The overwhelm-ing impression . . . is that . . . higher average in� ation is correlated withlower average economic growth’, and conclude that: ‘While the results arenot as robust as one would like, the most obvious interpretation of the evi-dence . . . is that the negative correlation between in� ation and growtharises from a causal relationship’ (p. 306). When one makes such strongclaims as ‘overwhelming’ and ‘obvious’ based on ‘fragile’ or ‘non-robust’estimates, it is dif� cult not to believe that the conclusions are driven bysome ‘articles of faith’.

Fortin (1993: 17) captured the sentiment of industrialized countrystudies: ‘Strong claims that there are large macroeconomic bene� ts to bereaped from a zero-in� ation monetary strategy are not presently foundedon robust quantitative evidence. They are premature’. In their study ofCanada, Germany, the US and UK, Cameron et al. (1996) found that theoften cited ‘stylized facts’ about the in� ation–growth relationship is a

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‘stylized � ction’. A similar result for Australia and New Zealand has alsobeen reported by Chowdhury and Mallik (1998). A more recent review byDebelle et al. (1998: 6) of the performance of seven industrial countries thathave formally adopted a pre-announced in� ation target (or a band) con-cludes with:

Still, it is probably too early to declare that the in� ation-targetingapproach has succeeded in delivering lower in� ation, given that in� a-tion has also generally declined in many industrial countries that havenot adopted in� ation targeting.

. . . Comparing unemployment in the in� ation-targeting countrieswith that in other major industrial countries shows that the averageunemployment rate rose signi� cantly in the early 1990s in the in� a-tion-targeting countries . . .

Bruno and Easterly’s (1998) work should perhaps draw the curtain onthe debate. Their investigation con� rms the observations of Dornbusch(1993), Dornbusch and Reynoso (1989), Levine and Renelt (1992) andLevine and Zervos (1993) that the in� ation–economic growth relationshipis in� uenced by countries with extreme values (either very high or very lowin� ation). Thus, Bruno and Easterly (1998) examined only cases of discretehigh in� ation (40 per cent and above) crises. The authors found a robustempirical result that growth falls sharply during high in� ation crises, thenrecovers rapidly and strongly after in� ation falls.

So the jury is still out on (a) the impact of ‘moderate’ in� ation on econ-omic growth, and (b) the performance of in� ation-targeting countries.

3 . IND O NE S IA N E V ID E N CE

Table 1 presents average annual in� ation rates and real GDP growth ratesin Indonesia since independence. Clearly, the 1960s were the worst periodof in� ation in the history of Indonesia, with an average annual in� ationrate of over 196 per cent and real GDP growth of only around 3.5 per cent.While there seems to be some association between high in� ation and lowgrowth during the 1950s and 1960s, the relationship does not appear to beso obvious in the later periods. During the 1970s, the average annual in� a-

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Table 1 Average annual real GDP growth and in� ation rates (%) (1950–97)

Decade GDP growth In�ation

1950–59 4.07 22.371960–69 3.47 196.021970–79 7.66 17.331980–89 4.77 9.401990–97 6.93 8.65

Sources: Woo et al. (1994: 167, Tables A1 and A2), BPS.

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tion rate was higher than it was either in the 1980s or 1990s, yet real GDPgrew at a faster rate. The small base of the initial growth might explain this

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y = 0.0052x 2 - 0.0387x + 0.0646

2 6

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2

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2 100 0 100 200 300 400 500 600 700

Inflation (%)

RG

DP

gro

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(%

)

Figure 1 In� ation and real GDP growth, 1950–97

y = 0.0356x + 0.0526

2 6

2 4

2 2

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2

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2 10 0 10 20 30 40 50 60 70 80 90

Inflation (%)

RG

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Figure 2 In� ation and real GDP growth, 1950–97 without outliers (in� ation rate >100%)

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apparent anomaly. Nevertheless, no clear pattern can be deduced from theannual average � gures.

Figures 1 to 3 are scatter diagrams of annual in� ation and growth ratescovering the period 1950–97. Two features stand out: (a) overall there is apositive relationship between in� ation rate and economic growth, and (b)there appears to be no relationship at in� ation rates between 8 and 15 percent. The scatter plot is also consistent with the � ndings of Bruno and East-erly (1998): the growth rate declines when the in� ation rate exceeds 40 percent. When we include the high in� ation era of the 1960s or the recentepisode following the crisis (in� ation rates greater than 100 per cent), we� nd a negative relationship between in� ation and economic growth. Butfor an in� ation rate between 5 and 18 per cent, we have both high and lowgrowth rates.

A recent econometric study of the Indonesian economy (covering theperiod 1984–99) by Siregar and Ward (this issue) shows that monetarypolicy does affect real output in the short run. Expansionary monetarypolicy reduces the interest rate and hence leads to a real exchange rateappreciation. Investment-induced output growth (due to a lower interestrate) is found to be greater than output contraction induced by net exports(due to real appreciation). Siregar and Ward (this issue) also �nd that � scalpolicy has signi� cant output effects due to nominal rigidity (sluggishnominal wage and prices).

Both the � ndings on the in� ation–growth relationship and effects of

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y = 0.0829x + 0.0542

2 2

0

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0 5 10 15 20 25 30 35 40 45

Inflation (%)

RG

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gro

wth

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Figure 3 In� ation and real GDP growth, 1970–97

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monetary policy on output have very important policy implications forIndonesia, especially during this recovery phase. It means that there isscope for a more relaxed monetary policy that will reduce pressure on thegovernment’s � scal position. For example, World Bank (2000: 20) estimatesshow that a 1 percentage point increase in the real interest rate will cost thegovernment about 0.3 per cent of GDP more in interest payment. Asobserved by the National Planning Agency (BAPPENAS 2001: 27), arelaxed monetary policy setting can ease � scal pressure:

Monetary policy aimed at lower interest rates . . . lower domestic debtservicing costs is now attractive for . . . budgetary reasons . . . higherinterest rates increase the interest cost on the large, outstanding stockof [debt] (currently equivalent to roughly 90 per cent of base money).This signi� cantly complicates the task of implementing monetarypolicy.

Such an environment would also help the banking sector which is suffer-ing from a cash-� ow problem and low pro� tability. In a depressed economy,commercial banks are forced to maintain a lower lending rate. But higherinterest rates on BI promissory notes, driven by an in� ation targetingpolicy, force the commercial banks to raise their deposit rate. This reducesthe interest margin and adds to the cash-� ow problems of the bankingsector.6 On the other hand, a somewhat relaxed stance on in� ation andlower interest rate policy has the potential to reduce the pressure on thegovernment to � oat another round of debt to recapitalize the bankingsector as required by the IMF.

However, one might argue that once monetary policy is relaxed and thein� ation rate is allowed to rise, it would be dif� cult and costly to bring thisrate back down. But the history of Indonesian macroeconomic manage-ment does not support this contention. In� ation was around 17–19 per centduring the 1970s and the average economic growth rate was over 7 per cent.

Reviewing the evidence for industrial countries, Debelle et al. (1998: 7)concluded that ‘the in� ation-targeting approach has been useful for thosecountries that lacked anti-in� ation credibility’. Bank Indonesia (BI) has avery good track record of controlling in� ation since the late 1960s.Although there were bouts of high in� ation in the 1970s, in� ation did notaccelerate. When in� ation shot up following the 1997 crisis, BI brought itdown remarkably quickly, as it did in the late 1960s.

Having said that, however, one must also note that the environment inwhich BI succeeded in keeping in� ation under control has changed signi� -cantly. To begin with, under the Soeharto regime price controls (especiallyof rice) by parastatals such as Bulog, together with fuel subsidy, played a keysupporting role. As part of the reform agenda, the role of administeredprices and subsidy will diminish. The second factor is the role of unions. Inthe past there was no danger of a wage–price spiral. But now that Indonesia

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has rati� ed all the International Labour Organization conventions onlabour rights, this may not be the case. Furthermore, there is a tendencytowards ‘catch up’ wage claims. In fact, there has been a marked rise inindustrial disputes since the collapse of the Soeharto regime. The thirdfactor is the increased openness of the economy and a � exible exchange rateregime. With the � exible exchange rate system, there is no nominal anchorfor in� ation, and an open capital account renders monetary policy (throughan interest rate instrument) virtually subordinate to the international capitalmarket. Fourth, liberalization of the � nancial sector also reduced the abilityof BI to directly control the monetary aggregates. Finally, heightened expec-tations due to democratic transition and decentralization may generateincreased demand on government expenditure – an issue taken up next.

4 . I NF L AT IO N T AR G ET IN G AN D CE N TR A L B A N KIND E PE N D E N CE D UR IN G TR AN S ITI O N

It is generally argued that within the type of competitive political system towhich Indonesia is currently moving, politicians are prone to makingmyopic economic decisions to secure voter patronage. This creates a biastowards � nancing public expenditure through borrowing from the centralbank rather than through taxation. Thus, the central bank’s anti-in� ation-ary policy loses credibility. In these circumstances, it is generally arguedthat insulation of the monetary authority from political interferenceenhances policy credibility and reduces output cost of anti-in� ationarypolicy.

However, given the theoretical controversy and inconclusive nature ofempirical evidence, can a case be made for a narrow in� ation targetingapproach?7 This is an important question, especially when Indonesia isundergoing political transition amidst growing social con� ict, and econ-omic recovery still remains doubtful.

To begin with, the success of an in� ation targeting policy depends on theful� lment of certain conditions. These conditions include the lack of � scaldominance and the absence of any other monetary policy objectives.Clearly none of these conditions are now present in Indonesia. Besidesworrying about economic recovery, BI also has to keep an eye onthe volatile rupiah. While the government’s � scal position is seriouslyconstrained by the huge debt obligation it acquired during the crisis, therevenue base remains very narrow, although it is currently helped by ahigher oil price. There are serious pressures on government to increase (orat least maintain) social expenditure in order to protect the vulnerable, aswell as to meet the expectations arising from the democratic transition.8

But in reality overall social spending in � scal year 2000 dropped by about40 per cent in real terms when compared with the pre-crisis spending level(F Y1995–96) (World Bank 2000: 23).

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The decentralization process has also added to � scal pressure. Thecentral government’s budget de� cit is likely to rise � rst because the processitself has heightened expectations and instability. The � scal de� cit may alsowiden if either more revenue than expenditure is decentralized, or revenueis allocated to regions that do not receive equally large expenditure (WorldBank 2000: 24). Thus, the government may be forced to accept a largerbudget de� cit. Given the weakness of the domestic capital market, and theproblem of Indonesia’s creditworthiness, the government will have nooption but to borrow from BI.9 This will destroy the credibility of BI’s in� a-tion targeting approach. Therefore, the credibility of BI and the effective-ness of in� ation targeting depend crucially on coordination between � scaland monetary authorities. The BI clearly recognizes the need for policycoordination, but does not offer any indication as to how this coordinationcan be achieved.10

In the absence of coordination, the problem can be partially resolved ifthere is a ‘rule-based’ � scal policy. In that case, the central bank can explic-itly incorporate the � scal parameters in determining its feasible in� ationtarget. The present government inherited a rule-based � scal policy fromSoeharto’s New Order, which stipulates a balanced budget and prohibitsborrowing from BI.11 Leaving aside the imaginative way in which these ruleswere adhered to under the past regime, one should ask how sensible it isto maintain them in the midst of democratic transition and decentraliza-tion when broader rules of the game are just evolving.

This brings us to the issues that relate to democratic governance andtechnocratic insulation of institutions. It is pertinent at this juncture toquote Milton Friedman (1962: 219) who is on record for voicing concernthat ‘. . . money is too important to be left to the central bankers’. In hisview (1985: 8)

The political objections are perhaps more obvious than the economicones. Is it really tolerable in a democracy to have so much power con-centrated in a body free from any direct political control? . . . Oneeconomic defect of an independent central bank . . . is that it almostinvariably involves dispersal of responsibility. . . . Another defect . . . isthe extent to which policy is … made highly dependent on personal-ities. . . . A third technical defect is that an independent central bankwill almost invariably give undue emphasis to the point of view ofbankers. . . . The defects I have outlined constitute a strong technicalargument against an independent central bank.

Stern and Stiglitz (1997: 277) make the point more succinctly:

The degree of independence of the central bank is an issue of thebalance of power in a democratic society. The variables controlled bythe central bank are of great importance and thus require democratic

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accountability. At the same time the central bank can act as a checkon government irresponsibility. The most successful economies havedeveloped institutional arrangements that afford the central bankconsiderable autonomy; but in which there is a check provided bypublic oversight, an oversight that ensures the broader national inter-est is taken into account in the � nal decisions.

In this respect, it is worth highlighting the distinction between ‘goal inde-pendence’ and ‘instrument independence’ (Debelle and Fischer 1994).The former refers to the central bank’s ability to set the in� ation targetindependently of the government; the latter refers to its independence inthe choice of instruments and hence relates to the central bank’s day-to-day operations. No central bank can be entirely independent of a demo-cratic government, but it can be entirely free in choosing its instruments.Several authors (e.g., Auerbach 1985; Frey and Schneider 1981) havepointed out that even the Federal Reserve System and the Bundesbank,which are considered highly independent in practice, follow the monetarypolicy of their governments, ‘In general, central banks with in� ation targetsare directly accountable to the government. Regular testimony to theparliament and the publication of annual reports have been the mainvehicles of this accountability’ (Debelle et al. 1998: 6).

Finally, central bank independence is not the only institutional arrange-ment for preventing in� ation from accelerating through a wage–pricespiral. An alternative institutional arrangement revolves around social con-sensus. There are various models of social accord between labour, govern-ment and business that can deliver a lower in� ation target and at the sametime increase the speed limit of growth.12 As a matter of fact, increasedsocial spending can play a critical role in achieving a social accord andmaintaining it. Social spending such as universal primary healthcare, freeeducation and other publicly funded welfare schemes may be regarded as‘social wage’ and are the government’s part in the social bargain. Thus, thegovernment’s ability to maintain social expenditure through in� ationary� nancing may act as glue that holds together the social compact. It is alsoworth noting here that such an institutional arrangement produceshigher investment (due to social harmony and trust between labour andbusiness).13

5. CO NC L UD IN G RE M A RK S

The usefulness of in� ation targeting is far from a settled issue. It is complexfor both theoretical and country-speci� c reasons. The essence of in� ationtargeting is embedded in the so-called social welfare function that includesboth in� ation and economic growth. The choice of weights in the socialwelfare function for in� ation and economic growth would have been

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easier if the relationship between them were straightforward. When therelationship is found to be positive in the short run or at a moderate rateof in� ation, society has to weigh the cost of low in� ation vis-à-vis the costof lost output. The choice becomes complicated because it also has toconsider the danger of higher in� ation and its likely negative effect onoutput. In the context of Indonesian transition, one has to evaluate the riskof a prolonged recession for democratic consolidation and social con� ict.In short, the question becomes: are the Indonesian people prepared to tol-erate the pain of high and prolonged unemployment that is associated witha technically driven and undemocratically determined in� ation target? Theanswer to this question requires a vigorous national debate. It is pertinentat this juncture to point to the observation made by a central bank insider,Guy Debelle (1996: 1):

An increase in the in� ation aversion of the central bank, while alwaysreducing [the] in� ation rate, may reduce welfare because of itsadverse effects on output and government spending. The net welfareeffect is shown to depend on the weights in the welfare functions ofthe � scal authority and society. Thus, increasing the central bank’sin� ation aversion is not necessarily a free lunch.

In general, while central bank independence reduces in� ation bias, theeffect on overall welfare is not unambiguous due mainly to the coordi-nation problem between the � scal and monetary authorities (Martijn andSamiei 1999). In that case, the reduction in the in� ation bias has to be bal-anced with the disadvantages of the absence of coordination. The problemof coordination in the case of Indonesia becomes enormous in the face ofthe nation’s democratic transition and decentralization. Indonesia needs tobuild national consensus to de� ne the policy games (i) between the centreand provinces, (ii) between provinces, (iii) between labour and employersand (iv) between the legislature and the executive president. This willde� ne the rules of policy interactions between the � scal authority and themonetary authority, which are needed for coordination.

When the rules of the game are still evolving through learning by doing,an independent BI with a technically determined in� ation target seems tobe putting the cart before the horse. As Valila (1999) has shown, the credi-bility of central bank independence and welfare gains depends critically ontransparency in making institutional reforms.

University of Western Sydney, Australia

A CK NO WL E D G E ME N TS

I have bene� ted from discussions with of�cials of the Bank Indonesia, BPS,BAPPENAS, Dr Satish Mishra, Mr Zulfan Tadjoeddin, Mrs Widjajanti and

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Mr Braskura Sudjana of UNSFIR. The seminar participants at the UNDPand the Indonesian Institute of Sciences (PEP-LIPI) also made usefulcomments. However, the usual caveats apply.

N O TE S

1 See Hossain and Chowdhury (1996) for a survey of the literature.2 Benjamin Higgins (1968: 678) described Indonesia as a ‘chronic dropout’ and

concluded that ‘Indonesia must surely be accounted the number one failureamong the major underdeveloped countries’. A similar assessment was offeredby Gunnar Myrdal (1968: 489): ‘. . . there seems to be little prospect of rapideconomic growth in Indonesia’.

3 The 1965 coup that effectively removed President Soekarno marked thebeginning of the New Order regime. However, of� cially the New Order is seento begin in 1968 when Soeharto formally became President of the Republic ofIndonesia.

4 See The Jakarta Post, 30 August 2000, and The International Herald Tribune, 26September 2000. Islam (2001) has discussed the employment implications oftight monetary policy during recovery.

5 BI’s immediate task was to obtain a 5–7 per cent in� ation rate (after allowingfor the increase in administered prices) and the medium-term in� ation targetis in the order of 3–5 per cent.

6 In a recent interview, the Chairman of the Indonesian Chamber of Commerceand Industry highlighted this problem in the following words: ‘Bank Indonesiahas been keeping interest rates high to ease pressure on the rupiah and stallin� ation. In response, the banking sector raised interest rates to prevent anout� ow of deposit funds into Bank Indonesia promissory notes. This activity,however, discouraged industries from making new investments that wouldotherwise have helped create new jobs’ (The Jakarta Post, 9 August 2001, p. 1).

7 Bank Indonesia’s immediate task was to obtain a 5–7 per cent in� ation rate(after allowing for the increase in administered prices) and the medium-termin� ation target is of the order of 3–5 per cent.

8 One World Bank estimate shows that more than 50 per cent of the populationremains vulnerable to poverty.

9 Currently, the government is barred from borrowing from the BI as part of thebalanced budget principle. See note 11.

10 See Bank Indonesia (2000); also see The Jakarta Post, 30 August 2000.11 The Soeharto regime maintained balanced budgets through imaginative

accounting where foreign aid and borrowings were included in the revenue side,and Presidential grants and defence expenditure were treated as off-budgetitems. Hill (1996: 59) has called the balanced budget principle a ‘� ction’.

12 See Chowdhury (2000) for details.13 For empirical evidence involving OECD countries, see Chowdhury (1994).

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