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The nature of the financial system is particular importance for conduct of monetary policy.
Briefly, Indonesia can be characterized as a bank-centered overdraft economy . The
domestic market in securities is not large enough to have great meaning either for the
financing of economic activity or for the regulation of the liquidity of economy, in contrast,
the deposit banking system is highly responsible for in some of the larger activities. Indonesia
is an overdraft economy not only in the sense that bank credit and apparently assured
borrowing power (the credit line) are important sources of liquidity for the economic agents,
but also in the sense that banks have been almost permanently in debt to the central bank.
Theoretically, in this situation, the direct control of credit is the efficient mechanism of the
monetary policy. However, in Indonesia, this rule is not applied completely. The purpose of
this study is to analyze the procedures and the degree of efficiencies of the monetary policy in
Indonesia during of 1969 until 1993. The debate over wether the monetary authorities should
attempt to control money or credit has not been particulary vivid in Indonesia, consequently
the control of credit implies the control of money and vice-versa. In practice, the growth of
the money supply (M2) has become a basis of its monetary control, within the target values
which are consistent with the ultimate objectives of the economic policy. Several instruments
of monetary policy which had been used are as follow. In the first period of Five Year Plan
(Repelita), the monetary authorities controlled the money creation of the commercial banks
indirectly by using the reserve requirement policy. However, the increase in oil price in 1973
have boosted the reserve money with the resulting increase in the money supply. For that
reason, in 1974, the monetary authorities gave up the direct control system by imposing the
credit ceiling with detailed sectoral credit allocation, and interest rate control. Then, in the
climate of reduced resource availability occasioned the serious decline in oil revenue at the
beginning of 1980s, coupled with the threat from the world recession, a financial
deregulation has been carried out by the monetary authorities in June of 1983. The main
objective of the reformation was to make the financial system more efficient and self reliant
in mobilizing and allocating financial resources. According to the new system, the procedures
to influence the growth of money and credit will require both controlling the monetary base
and the monetary multiplier (the System of Reserve Money Management) with the interest
rate as the principal instrument. The test of efficiency of the monetary policy has been
measured by the following issues: a close relationships, the predictability and the direction of
causality between the policy instruments (operational objective) and the intermediate
objective, and also between the intermediate objective and the ultimate policy objectives. A
regression analysis has been employed to test the reliability of the relationship between the

objectives. To confirm the stability of the forecasting quations, a standard test statistics have
been employed as the THEILs U statistic. The test for the direction of causality was an
application of SIMSS technique for determining the causal ralationship between the
objectives. The results indicated that the monetary autorities have no control over the
intermediate objective M2, because the m2 money multiplier was unpredictable and that
changes in the monetary base has been largely determined by the amount of the credit and
money created by the banking system. However, the test of efficiency of the monetary control
in order to the ultimate objectives demonstrates the results : that variations of the monetary
aggregates M2 and the credit variable have a significant influences on the economic activity
(GDP), on the inflation rate and on the distribution of income. Keys words: Financial System,
Overdraft Economy, Monetary Creation, Transmission Mechanism, Control of Money and
Credit, THEILS U and SIMSS tests.