External shocks and macroeconomic policy in Indonesia

Indonesia has an open, developing economy that is strongly affected by external shocks, the most damaging of which have been the Asian Financial Crisis (AFC) and the Global Financial Crisis (GFC). It is shown that their impacts on output, employment and external balance depended on Indonesia's monetary target and on the government's fiscal response. Both structural modelling and dynamic econometrics are applied to historical data to show that a flexible exchange rate regime and strongly countercyclical fiscal policy are required when such crises occur and that these would likely have alleviated much of the damage done during the AFC.