Effects of External and Domestic Shocks on the Indonesian Macroeconomy

Abstract

As a small open economy country, Indonesia is exposed to various external and domestic events that can potentially interfere its domestic macroeconomic stability. Hence, it is necessary to have appropriate policies in order to reduce the excessive fluctuations in economy. The aim of this study is to assess the main shocks affecting the domestic economy and also to find out domestic macroeconomic responses when shocks happen. To achieve aforementioned objectives we use a SVECM method with a set of short run restrictions based on the New Keynesian framework. This study finds that the domestic shocks hold an important role for the fluctuations of the domestic macroeconomy, meanwhile the external shocks including world oil price shock have less important role. Demand shock, ultimately real exchange rate shock, evidently become as important as supply shock, which is permanently responded by GDP and the real exchange rate. Moreover, this study also find that money neutrality occurs both in the shortrun and long-run.