Inflation And Economic Growth: Estimation The Threshold Level In Indonesia

Abstract

High inflation is regarded as a problems in the economy. Indonesia experienced economic collapse as a result of failing to control inflation volatility. This is used as a reason for the current authorities to implement low-inflation policy. The economist argues that low-inflation can promote economic growth faster. In fact, low-inflation policy is not favorable because it interferes the business investment climate. On the other hand the pattern of the inflation and economic growth data in Indonesia is also inconsistent (indicating a positive relationship, negative and neutral). The purpose of this study is to determine the effect of inflation on economic growth, as well as to search inflation threshold in Indonesia in the period 1970- 2012. Using multiple linear regression, this study shows that inflation negatively impacts on economic growth. Inflation threshold identification by Khan and Senhadji model (2001) stated that inflation threshold in Indonesia is 7.11%. While according to Hansen model (1997, 2000), inflation threshold in Indonesia is 9.53%. Based on some model selection criterias, the inflation threshold implied by Hansen model is more apropriate. Inflation has a positive effect on economic growth if the value is less than the thresholds and negative when it exceeds the thresholds. This result supports Chowdhury and Ham (2009) finding who stated that inflation threshold in Indonesia is between 8.5 per cent and 11 per cent. The two studies imply that the central bank should only pursue active policy measures when inflation is above the threshold. Thus, ITF cannot be generalized to all levels of inflation.