The Effect of Money Supply and Government Expenditure Shock in Indonesia: Symmetric Or Asymmetric?

Abstract

It has been more then four years since the economic crisis in Indonesia. While other Asian countries such as South Korea and Malaysia have shown significant improvement, Indonesia seems to have the slowest economic recovery process. In order to deal with the economic crisis, the government has imposed several policies, both monetary and fiscal. This paper tries to achieve two objectives; first, it tries to determine the existence of an asymmetric reaction of output and inflation to government expenditures and the money supply, and second, it tries to find the best policy to deal with the economic crisis, i.e., to determine which policy generates a larger and quicker response to output. It contains an overview of government expenditures and the money supply in the pre-crisis year, theoretical background and data analysis. The results of the study show that a shock in government expenditures has a significant effect on changes in output, and that the effect is asymmetric (positive shock has a larger impact than negative shock), while a money supply shock does not have a statistically significant effect on output. The paper concludes with three important government policy implications. First, the government must reallocate its spending, i.e. allocate more to development expenditures which will increase the productive capacity. Second, since Indonesia currently has a huge debt burden, it is not necessary for the government to increase its expenditures, since the effect on output reduction is not statistically significant. Third, the monetary authority should not use a shock in money supply to boost output, but it should focus on its function in delivering a low level of inflation