The Short-Run and Long-Run Effects of Central Bank Rate on Exchange Rate Volatility in Indonesia

Abstract

This research measures the short and long-run effects of central bank policy rate on the volatility of the exchange rate in Indonesia using the quarterly data from Q1 1992 to Q4 2019. The process involves applying an Autoregressive Distribution Lag estimation to investigate the effects of the variables. The exchange rate volatilities include Indonesia Rupiah to US Dollar (IDR-USD), Indonesia Rupiah to Singapore Dollar (IDR-SGD), Indonesia Rupiah to Australia Dollar (IDR-AUD), Indonesia Rupiah to British Pound Sterling (IDR-GBP), and Indonesia Rupiah to Euro (IDR-EURO). Several results were obtained and the first to show the adjustment time for exchange rate volatility to achieve long-run equilibrium was 1.77 quarters to 2.26 quarters using the ARDL estimation. Secondly, a decrease in the central bank rate was found to significantly reduce the exchange rate volatility in the short run and long run. These results are robust since Full Modified Ordinary Least Square (FMOLS) estimation was applied for all five models. Furthermore, it was found that in the long run, the central bank policy rate had a significant positive effect on the volatility of the Indonesia Rupiah against five foreign exchange rates. Therefore, it was suggested that the policymakers need to keep the interest rate of the central bank low and stable to ensure the Rupiah exchange rate stability.

Monetary Policy and Investment in ASEAN-5 Countries

“…This means that an increase in interest rates will be followed by an increase in investment in the ASEAN-5 region. The results of this study are in accordance with previous research conducted by Awad (2020) and Suhendra et al (2022), in which the results show that in the long term, interest rates have a positive and significant effect on investment. However, in the short run, the central bank interest rate has a positive but insignificant effect on investment.…”

“…This rate has been assumed by Cloyne et al (2023), Ottonello and Winberry (2020), Givens and Reed (2018), Durante et al (2022), Zhang et al (2020), and Döttling and Ratnovski (2023) to have a negative effect on investment due to higher interest rate. According to earlier research, several control factors having sizable impacts on investment were introduced, such as Suhendra et al (2022) and Anwar et al (2023) found the positive impact of economic growth on investment due to the increasing demand for credit. Inflation was also added as an explanatory variable and defined as an increase in the consumer price index.…”

“…Additionally, Awad (2020) found that interest rates had a detrimental influence on investment in Malaysia. According to Suhendra et al (2022), interest rates significantly and negatively affect investment.…”

Green Bonds, Investor Attention and Stock Market Reaction: Evidence from ASEAN Countries

“…They also found that this effect was stronger for corporate issuers with less concentrated holdings and those held by longterm institutional investors. Other studies have also reported that most stock markets react positively to the issuance of green bonds (Kuchin et al, 2019;Glavas, 2020;Suhendra et al, 2022;Ul-Haq et al, 2023).…”

Bank Systemic Risk in Indonesia

“…Thiemann et al (2021) reinforces the notion that a financial institution crisis poses a threat to the entire financial system and generates systemic risk, resulting in a substantial impact. The Prime Mortgage Crisis started with the failure of a US financial institution, subsequently spreading throughout the financial system to trigger a global systemic crisis and a downturn in the global economy (Tori et al, 2023;Suhendra et al, 2022).…”