28 Apr 2016

Countercyclical Fiscal Policy in Indonesia

Abdurohman, 2013
The Australian National University

Abstract
The main objective of this thesis is to provide a comprehensive analysis on countercyclical role of fiscal policy in Indonesia. Three main goals are derived in order to address the main objective of the thesis. The first goal is to document and review fiscal policy responses to the different types of economic shocks in Indonesia since the 1970s. The second goal is to conduct an empirical examination of the practical behaviour of fiscal policy in Indonesia in response to economic cycles. Lastly, the third goal is to provide an empirical assessment of the effectiveness of fiscal policy in Indonesia in stimulating economic activities.

In addressing the first goal, the thesis documents five major economic shocks that had a major effect on the Indonesian economy along with the typical budgetary policy responses that followed. The policy review suggests that during the oil price related shocks, the government appeared to have no intention to implement countercyclical fiscal policy during oil booms (1974 and 1979), which in turn prevented the government from running fiscal expansion during the oil shock in 1986. However, in both the Asian financial crisis and global financial crisis, the government seemed to have the intention to pursue countercyclical fiscal policy. Nonetheless, a lack of financial resources and weak budget execution hampered its capacity to pursue such a policy.

The second goal of the thesis is achieved by conducting empirical examinations using the error correction model and the alternative model. The results conform to the policy review above, in which the government has been unable to implement countercyclical fiscal policy.

The third goal of the thesis is addressed by utilizing two different models: the structural vector autoregression (SVAR) and the inter-regional CGE model. Using the SVAR model, the results suggests that total government spending has a positive impact on output. The findings also indicates that the spending composition is important as indicated by the positive impact of government capital spending both on output and private investment, while government consumption spending has a negative impact on output and private consumption.

From the inter-regional CGE model, there are three important primary findings. Firstly, the 2009 fiscal stimulus package has a positive impact on output and poverty reduction. Secondly, while in the short-run, the impact on output seems to be distributed unevenly, in the long run, however, a more even distribution across regions is achieved due to the efficiency gain resulted from the infrastructure spending, which benefits more to the relatively less-developed regions. Thirdly, the result points that infrastructure spending is likely to be the most effective tool to stimulate output in the long run as well as to improve equality across regions. However, if the top priority of the Indonesian government is poverty alleviation, cash transfer should then be the optimal policy option.

In general, the thesis finds that while the government of Indonesia has difficulty in implementing countercyclical fiscal policy, the evidence suggest that countercyclical fiscal policy has a potential role in stabilizing the economy, especially during a downturn.

Share this article on:

Related Article


Back to Top