Understanding the Dynamics of Indonesia's Economy: Challenges and Solutions Amid Global Uncertainty

By Sanjoyo

In recent months, Indonesia's economy has shown various intriguing dynamics. Despite global challenges, Indonesia has managed to maintain stable economic growth while leveraging available opportunities. Let's take a closer look at the latest developments, notable issues, and potential solutions to address these challenges.

Stable Economic Growth. Indonesia's economy has demonstrated stable growth, with GDP projected at around 5% in 2023. This growth is supported by strong domestic consumption and continuous investment, particularly in infrastructure and technology sectors. Government policies, such as the Omnibus Law, have also provided a boost to the investment climate, although some challenges remain to be addressed.

Current Notable Issues

1. Food and Energy Prices. One of the main concerns is the rising prices of food and energy. The surge in rice and cooking oil prices is caused by global supply chain disruptions and climate changes affecting domestic production. This directly impacts people's purchasing power and economic stability.

2. Global Uncertainty. Global uncertainties, particularly due to the Russia-Ukraine war and international trade tensions, have negatively affected trade and investment. Fluctuations in commodity prices, such as oil and gas, also significantly impact Indonesia's economy.

3. Health and Post-Pandemic Economic Recovery.  Although COVID-19 cases have declined, economic recovery still faces various challenges. The tourism and MSME sectors require full support to recover and contribute optimally to the economy.

4. Digitalization and Economic Transformation. Increasing adoption of technology and digitalization is a primary focus for both the government and the private sector. This transformation is crucial for improving efficiency and competitiveness in the global economy.

Propose Policies Direction. 

To address these challenges, several strategic steps can be taken:

1. Price and Subsidy Policies. The government needs to strengthen price and subsidy policies to maintain food and energy price stability. Support for farmers and the agricultural sector should also be increased to boost domestic production.

2. Economic Diversification. Reducing dependency on commodities by strengthening the manufacturing and service sectors can enhance economic resilience. Investment in technology and innovation should be encouraged to create a more dynamic and competitive economy.

3. Infrastructure Strengthening. Continuous improvement of physical and digital infrastructure is necessary. Major infrastructure projects, such as the construction of toll roads, ports, and internet networks, need to be expedited to support long-term economic growth.

4. Support for MSMEs and Tourism. Expanded assistance and incentives for MSMEs and the tourism sector are essential. Training and financial access for MSMEs should be increased to support economic recovery and growth.

5. Global Risk Management. Developing risk mitigation strategies against global uncertainties is crucial. Diversifying export markets and strengthening international cooperation can effectively reduce the negative impacts of global uncertainties.

With appropriate policies and support from various stakeholders, Indonesia can continue to grow and overcome existing economic challenges. It is important to continuously monitor global and domestic developments and adjust policies as needed. By doing so, Indonesia can maintain its economic stability and progress amid global uncertainty.

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Indonesia's Future Economy

Indonesia's future economy is poised for significant growth and transformation, with the resource sector playing a crucial role. As one of the world's largest archipelagic nations, Indonesia boasts abundant natural resources, including oil, natural gas, coal, minerals, and a vast expanse of forests. Historically, these sectors have been major contributors to the country's economy, generating significant revenue and employment opportunities. 

However, Indonesia is increasingly recognizing the need to diversify its economy and reduce its dependence on resource extraction. While the resource sector will likely continue to play a vital role in the economy for the foreseeable future, there is a growing emphasis on sustainable development and leveraging these resources more efficiently and responsibly. 

Here are some key aspects of Indonesia's future economy and the role of resource sectors:

Diversification: Indonesia aims to diversify its economy by promoting other sectors such as manufacturing, tourism, technology, and services. This diversification strategy is intended to reduce the economy's vulnerability to fluctuations in commodity prices and global demand for resources.

Sustainable Development: There's an increasing focus on sustainable development practices within the resource sectors. This includes efforts to minimize environmental degradation, promote renewable energy sources, and adopt responsible mining practices. Initiatives like the Sustainable Development Goals (SDGs) provide a framework for guiding these efforts.

Infrastructure Development: The development of infrastructure is essential for unlocking the full potential of Indonesia's resource sectors. Investments in transportation, energy infrastructure, and telecommunications are critical for improving accessibility to remote resource-rich areas and facilitating efficient resource extraction and distribution.

Technology and Innovation: Embracing technological advancements and innovation is crucial for enhancing productivity and competitiveness in the resource sectors. Technologies like automation, artificial intelligence, and remote sensing can improve efficiency, safety, and environmental sustainability in mining, oil, and gas exploration, and forestry operations.

Value-Added Processing: Instead of solely exporting raw materials, there's a push to promote value-added processing within Indonesia. This involves developing downstream industries to refine and process raw materials domestically, thereby capturing more value and creating higher-skilled jobs.

Government Policies and Regulations: The Indonesian government plays a central role in shaping the future of the resource sectors through policies, regulations, and incentives. It needs to strike a balance between attracting investment, ensuring environmental protection, and maximizing benefits for local communities.

International Partnerships: Collaboration with international partners and investors can bring in expertise, technology, and capital to support the development of Indonesia's resource sectors. However, it's essential to negotiate fair deals that prioritize the long-term interests of Indonesia and its people.

In summary, while the resource sectors will remain significant drivers of Indonesia's economy, the country is actively pursuing strategies to diversify its economy, promote sustainability, and maximize the value derived from its abundant natural resources. Balancing economic development with environmental and social concerns will be crucial for ensuring a prosperous and equitable future for Indonesia. 

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Indonesia Economic Growth

• In the 2015-2019 period, 11.88 million jobs were created. In August 2019, TPT fell to 5.28 percent compared to last year's 5.34 percent.

• The tourism sector, as one of the drivers of the Indonesian economy, is experiencing good progress. According to The Travel & Tourism Competitiveness Report released by the WEF (World Economic Forum), the ranking of Indonesia's tourism competitiveness index in the world rose to 40 in 2019 from 42 in 2017.

• The interest of foreign tourists or tourists to Indonesia is increasing, it is shown that November 2019 data has increased by 11.55 percent compared to the number of visits in November 2018.

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Monetary Policy and Economic School of Thought

Monetary Policy and Economic School of Thought. The influence of monetary policy on output and prices is a long debate concerning both theoretical and empirical terms. This is not detached from the economic development school of thought from start Classical, Neo-classical, Neo-classical synthesis, New Classical and New Keynesian.

In Classical view, money affect only the price and not to the output. By using analysis general equilibrium, included money in the model showed the money neutrality that money does not affect on market equilibrium. On the other hand, the Keynesian view of money affects prices and output because of the price rigidity and involuntary unemployment. This view is modeled on the IS-LM for the equilibrium of money market and goods market and disequilibrium on the labor market.

In the 1960s there consensus view that the money may affect output and prices in the short term (Neoclassical Synthesis). In that period, structure of the labor market is replaced with Phillips curve as aggregate supply. Neoclassical Synthesis model explained that the occurrence of rigidity prices and wages because of the assumptions in determining the behavior of company that is the price mark-up of wages. Although the real wage is flexible, but the pricing behavior conducted in the mark-up so lead to occurring rigidity wages and prices and then money supply affect real output and prices.

Expectation economic agent face economic uncertainty will influence macroeconomic. Two important hypothetical of expectation in the economy are rational expectation and adaptive expectation. Milton Freidman (1957) introduced the adaptive expectation that the expectation economic agents formed by observations of inflation at this time. Phenomenon of the Phillip curve was challenged by Friedman points out that the argument only unanticipated inflation are affecting unemployment. He emphasize on the importance of expectation on the aggregate supply so that revised Phillips curve as expectation-augmented Phillips curve.

On 70’s, it is difficult period for the Keynesian. Lucas (1976) and Sargent-Wallace (1975) introduced the rational expectation that assume economic agents use all relevant information to establish expectation or forecast economic variables in the future. So that monetary policy and fiscal policy affects inflation, than expectation inflation also depend on effect those policies. Thus, changes in monetary and fiscal policies affect the changes expectation agent economy. So, the policy evaluation must consider the effects of expectation economic agents.

Lucas (1976) criticize the results of parameter estimation econometric model that is not stable because occurring the changes policy maker behavior, and than expectation of the private agent will also be changed then it will affect the parameters in the econometric model. This critique affect on two, the revised macroeconomic model with rational expectation of entering and strengthening macroeconomic model with micro foundation.

At the 80’s Classical school of thought was extremely dominant. In the New Classical paradigms, Kydland - Prescott (1982) introduced the real business cycle theory (RBC), which begins with microeconomic assumption of household consumption preference, the production firm and market structures. With the intertemporal optimization of consumption of households and future profit of firms and the market is competitive then the solution obtained by dynamic general equilibrium model. They succeeded in making data replication USA. RBC model assume output is always in the natural level of output and all of output fluctuations are the movement of natural level of output itself. The cause of output fluctuations in Prescott point of view is a shock or a change in technology. Similarly, in the RBC model change in money supply does not affect output.

After the 80’s, research on RBC develop in many models. Debate on technology shock provides inspiration for researchers to develop various models incorporate various aspects, among others; oil shock, fiscal shock, monetary model, and the multiple equilibrium model (Rebelo, 2005).

The latest research on the RBC model related to monetary policy is to include elements of nominal wage and price rigidity in the model, so that changes in money supply can affect output. This model, known as Dynamic Stochastic General Equilibrium (DSGE) model. Some researchers Christiano, Eichenbaum and Evans (2003), Woodford (2003), Smets and Wouters (2004); and Laxton and Pesenti (2003) build and estimate DSGE model based RBC with assumptions nominal rigidities in wage and price, including assumption imperfect competition in market labor market and product market.

Another mainstream New Keynesian is the improvement of the Neo-Classical synthesis with incorporate aspects of the rational expectation and strengthening the micro foundations. However, the Keynesian economists still believe the existence of imperfect markets and nominal rigidity can lead to fluctuations (deviation) of output from natural output. Fischer (1977) and Taylor (1980) argued that the occurrence of the nominal rigidity caused staggering of wage and price decisions by firms. The existence of staggering in wage and price lead to adjustments on price level slowly so that changes in aggregate demand impact on output fluctuations.

In New Keynesian paradigms, the economists [Gali and Gertler (1999) and Gali et al. (2001), Roberts (2001), Fuhrer (1997); Linde (2005)] has to learn how to develop a simple model, related, and structural that could explain mechanisms transmission of monetary, especially through the interest rate and the impact on inflation and output. This model is known as model New Keynesian Small Macroeconomics (NKSM) with approach dynamic stochastic general equilibrium that contain aspects expectation and also solid with micro foundation. This simple model is also containing the aggregate demand, price-setting (Phillips) curve, and the reaction of an interest rate policy to output and inflation. This model to realize the basic principle of the role of monetary policy instruments through the nominal interest rate to inflation stabilization.

Technically DSGE models have weaknesses in terms of technique calibration that difficult to create the replication of data in accordance with the actual data, but the advantage that the DSGE model parameter is the "deep parameters" (parameters for the micro variables). While NKSM have benefits to explain economic conditions simpler, but the weakness is difficult to get the relationship between variables significantly because of the unobserved variables or serial correlation.

Paper in Indonesia Language.
Keyword: Classical, DSGE, Economic, IS-LM, Neo-classical, Neo-classical synthesis, New Classical and New Keynesian, Phillips curve, Price rigidity, Rational Expectation, RBC, wage rigidity.

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