Iwan J. Azis

What Would Have Happened in Indonesia if Different Economic Policies Had Been Implemented When the Crisis Started

Many models of the Indonesian economy cannot generate the large collapses in output and exchange rate experienced in 199798. The model in this paper was able to replicate the actual events by adding several new links. One new link is between the depreciation of the exchange rate and the deterioration of the balance sheets of firms, which are in turn linked to decline in investment. Another new link is between decline in output and decline in business confidence, leading to possible increased capital outflow and exchange rate collapse. The IMFs high interest rate policy did not succeed in strengthening the rupiah because it inflicted such severe damage on the net worth of Indonesian firms that it caused capital flight to accelerate, turning what was originally just a financial crisis into a major recession. Two alternative counterfactual policy packages are examined: (1) a lower interest rate policy and (2) a lower interest rate policy combined with a partial write-down of the external debt. The model indicates that the countrys macroeconomic conditions would have fared better if the prolonged high interest rate policy had been avoided. The results suggest that early actions should have been undertaken to address the mounting private foreign debts. The delayed handling of private debts had prevented other policies from working effectively. The two counterfactual policies also would have resulted in a more favorable outcome for income distribution and poverty incidence. The model revealed a close correlation between worsening (improving) income distribution and increasing (declining) interest rates.

Measuring Economy-wide Impacts of a Financial Shock

This article analyses the transmission of financial shock to household income distribution using the case of Indonesia. Presumably, those benefiting from currency depreciation and high interest rate during the crisis are the high-income groups. However, the same groups might lose since they were employed in sectors that are highly import-dependent. On the production side, construction was the hardest-hit sector during the crisis, and thus the low-income non-agricultural households were more susceptible due to their heavy reliance on manual work in construction. This sector also proves to be instrumental in transmitting the shock from the credit crunch to the fall in household income. To the extent that a formal social safety net is lacking, an informal system of inter-household network is expected to mitigate the impact on the poor. However, we found that there is no convincing evidence that households acted altruistically to assist their distressed neighbours during the crisis.

Global Shock and Regional Spillovers

Abstract When global crisis struck at a time of great global and regional interdependence, contagion occurs; it can work via capital flows or through spillovers of the returns/yields on financial assets. The analysis in the paper deals with the latter. Focusing on the shocks in the United States and Eurozone bonds market, and using multivariate GARCH models with conditional variance-covariance matrix being positive definite, it is shown that the shock and volatility spillovers in some emerging Asian countries are quite significant. They spread throughout different asset classes, threatening the region’s financial stability, and making it more difficult for the policy response to focus on a particular market. Although local bonds volatilities are more determined by their own respective shocks and volatilities, in some markets the direct shock and volatility spillovers remain significant; so does the indirect spillovers within domestic asset markets and across economies. Absent of policy coordination within and across countries. Such undesirable spillovers due to other country’s unilateral policy can be damaging. Growing financial nationalism in the midst of a crisis is likely to spark strong reactions from affected countries, potentially creating a conflict situation.

A regional trend towards a basket peg system

Exchange rate volatility can be detrimental to growth and stability. For East Asian countries, a common basket system can be a way to reduce such volatility. By evaluating the weights of the dollar, the yen, and the euro in individual countrys exchange rate, the paper shows that post-crisis fluctuations of regional currencies are no longer determined by the US dollar alone. Should the region decide to adopt a common basket, therefore, it is consistent with such a trend. The regional exchange rates also have not uniformly functioned as a stabiliser, suggesting there is a room for a basket peg system.

Theory of Endogenous Institutions and Evidence from an In-depth Field Study in Indonesia

We study how endogeneity between welfare and institutions recommends the efficacy of subtle institutional reforms that must be exogenous. We use evidence from a field study conducted in five Indonesian districts, and build a model that illustrates how initial socioeconomic conditions and quality of institutions generate certain institutional attributes, such as a particular level of local capture (that is, gaining of influence over institutions, and hence over policy, by local elites), local leadership and participation. These institutional attributes, which evolve with changing welfare, create self-reinforcing processes in the long run that could be either vicious, virtuous or neutral. The policy question we investigate is how to break a vicious cycle between low welfare and low institutional quality. Reform must be exogenous and multi-dimensional, requiring welfare and institutions to be mutually reinforcing. In the context of post-decentralization Indonesia, any multi-dimensional institutional reform must include not only policies to strengthen local institutions, but also policies to increase welfare

A Cooperative Analysis Procedure for Use by Diplomats and Negotiators: With a Proposed Step for Resolving Conflict on the Korean Peninsula

This paper is concerned with the development of a cooperative analysis approach for use by Diplomats and Negotiators in resolving certain difficult conflicts. It employs concepts from economics and peace science without any diminution of the urgent need for superb diplomacy and negotiations skills. Its potential use for resolving the major conflict in the Korean peninsula is explored. A policy option is set forth involving a small withdrawal of North Korean troops from North Korea’s Eastern DMZ border for economic development in that area of North Korea without any reduction whatsoever of the North Korean military power. For each party involved, benefits significantly greater than costs are found for this policy.

Integration, Contagion, and Income Distribution

The 2008/2009 global financial crisis and the unprecedented policy response in advanced economies have a worldwide impact. The episode also led many to question the standard framework of economic thinking on regional integration, financial liberalization and their repercussions on income disparity. The paper argues that one needs to take a balanced view on integration—not just the benefits but also the risks. If regional integration leads to greater inequality, the expected growth and prospect of improved welfare can be diminished. Utilizing a general equilibrium framework, it is also shown how financial liberalization and the surge of capital inflows can produce not only financial instability but also worsening income disparity. By combining model-based results and theory-based ranking applied to the Asian case, and considering the benefits, opportunities, costs and risks of alternative policies, it is revealed that imposing levy on bank-led flows can be used to reduce instability and inequality. This type of macro-prudential policy reflects a departure from the ‘First Best’ to the ‘Second Best’ approach of liberalization, where the frictionless outcome of the former is seriously questioned.

Indonesia's Slow Recovery After Meltdown

Although signs have emerged that some of the forces that caused the 199798 Asian financial crisis have begun to diminish and progress has been made in macroeconomic affairs, 10 years after the meltdown Indonesias recovery is still among the slowest in Asian crisis countries. During the last few years, the relatively rapid growth of the financial sector (inadequately restructured) reflects the presence of excess liquidity and the sectors vulnerability. The slow growth of investment explains the economy-wide effects on the real sector and the stagnancy or deterioration of some social indicators. This paper focuses on two issues related to the slow recovery: the financial structure of lenders and borrowers that dampened credit, and the dismal performance of regional growth following the 2001 decentralization policy. There is some evidence indicating that agency costs have slowed credit and investment growth (credit channel), and that institutional constraints produced a lack of growth incentives among local governments. Efforts to raise the sub-national welfare post-decentralization have also been constrained by national policies such as a tight budget and the relatively conservative monetary policy despite the fact that they are not too effective at controlling inflation. The decomposition analysis also shows that an aggregate demand expansion would have been effective to stimulate growth.

How Capital Flows in the Midst of Excess Savings Affect Macrofinancial Vulnerability

In contrast to the period prior to the 1997/98 Asian financial crisis, emerging East Asia today is a region with excess savings, particularly corporate savings. Beginning in the mid-2000s, liquidity was further amplified by massive capital flows, particularly bank-led flows, and subsequently by debt-led flows following the introduction of quantitative easing in the United States. Both types of inflows are critical for bank-dependent Asia in need of long-term financing for infrastructure development. Yet, these two types of capital flows are also the most volatile. The surge of inflows in the midst of excess savings helped raise liquidity and growth, but also posed serious challenges to financial stability. As revealed by flow-of-funds data, the risk-taking behavior of economic agents and their preferences toward financial assets increased. Bank-led flows increased noncore liabilities and caused a credit boom, elevating the risk of procyclicality, while debt-led flows raised the vulnerability to a reversal of flows. These inflows also lowered the effectiveness of monetary policy, underscoring the need to supplement standard measures with a more effective macroprudential policy.

Four‐G Episode and the elevated risks

Complacency and a false perception that markets will correct imbalances during two decades of ‘Great Moderation’ led to ‘Global Imbalances’. The low interest rates and a lack of proper oversight, combined with a perception that housing prices will always move north, brought the sub-prime crisis in the USA and the subsequent ‘Global Financial Crisis’ and European crisis. The Quantitative Easing policy in advanced economies (AE) created an even more permissive global liquidity. The externality affecting emerging markets (EM) took the form of massive capital inflows, first channelled through banks where the global banks-mostly headquartered in Europe-played a significant role and then through capital market with fund managers being the protagonist. The augmented liquidity spurred growth in EM but also elevated the risk of financial instability. Capital flows reversal, slower growth and less benign external conditions have put EM in a quandary. The uncertainty is heightened by a non-synchronised monetary policy in AE (‘Great Divergence’). To the extent that standard policies have become ineffective, and to defend from externality caused by AEs unilateral policy (financial nationalism), it is argued that EM can put a damper on the dangerous component of capital inflows. As part of macroprudential policy, such a measure is equivalent with discouraging risky behaviour to prevent financial instability and worsening income inequality.