Choi-Meng Leong,

UCSI University,

Kuching, Malaysia,

E-mail: mandyleongcm@gmail.com

The Impact of Divisia Money on Monetary Model of Exchange Rate in Indonesia

Chin-Hong Puah,

Universiti Malaysia Sarawak,

Kota Samarahan, Malaysia,

E-mail: chpuah@unimas.my

Venus Khim-Sen Liew,

Universiti Malaysia Sarawak,

Kota Samarahan, Malaysia,

E-mail: ksliew@unimas.my

Abstract. Stability of the exchange rate is critical for policy formulation in Indonesia and thus, has boosted the study of exchange rate behaviour. In this study, the monetary model of  exchange rate has been utilised to determine the exchange rate for Indonesia. The model was improved by means of including the Divisia monetary aggregate as the money measure instead of conventional money supply. The ARDL approach, which was valid in spite of the variables’ stationary properties, was used for the estimation. The findings indicated that monetary fundamentals are significant in explaining the exchange rate movements in Indonesia when Divisia money was incorporated into the monetary model of the exchange rate. As a result, monetary fundamentals can serve as the determinants of exchange rate in addition to non-monetary fundamentals in the case of Indonesia. High magnitude of the money supply differential and the real income differential coefficients also implied that monetary targeting can serve as a useful instrument for monetary policy in addition to inflation targeting. The research is based on the data ranging  from 1984Q1 to 2017Q1.

Received: January, 2018

1st Revision: March, 2018

Accepted: May, 2018

DOI: 10.14254/2071-789X.2018/11-2/4

JEL Classification: E41, E52, C22

Keywords: a monetary model of exchange rate, Divisia monetary aggregates, bounds testing, Indonesia