Notes on A New Monetary Policy

Monetary policy restrict

 Policy Response to Covid-19 Pandemic 

IO – One of the key policies instituted by the Government of Indonesia reported by President Joko Widodo in his state address to the People’s Consultative Assembly on August 14, 2020 was the collaborative steps taken by the Government and the Financial System Stability Committee (KSSK in Indonesian) on national efforts to address the Covid-19 Pandemic that has become the biggest challenge for the management of public health and the national economy. The President was referring to the Law no 2 of 2020, The Coronavirus Economic Reform Package Omnibus Act 2020. 

The policy package includes the use – for the first time – by Bank Indonesia (B) of quantitative easing (QE) as a new means of monetary stimulus. It is exercised by way of BI purchase of long-term government bonds in the primary market. There are 12 other emerging economies resorting to the use of QE for the first time, all entering new and unchartered territory. In Asia South Korea, India and the Philippines, the others include Turkey, South Africa, and several eastern European countries. 

The term QE was coined when a policy of liquidity creation was initiated by the Fed in 2008 as a policy response to the financial crisis originating from the subprime mortgage loans meltdown, tracking the bankruptcy of Wall Street mega bank Lehman Brothers in September, the effects of which spread like wild fire that year to become a global financial crisis (GFC). As the instrument used in the policy introduced by the Fed then was out of the ordinary, it has since become known as unconventional or modern monetary policy. 

There has been much written, assessing the Indonesian government policy in responding to the Covid-19 pandemic as public health policy; some has not been flattering, accusing the policy response to the onslaught as slow, confused and lacking coordination, ineffective, a failure and the like. But these contentious points are not what I am discussing here. My focus is on certain financing aspects of the policy package addressing the pandemic. 

The new Act provides a legal basis for the Government and KSSK, comprised of the Ministry of Finance, Bank Indonesia, the Financial Services Authority (OJK) and the Deposit Insurance Corporation (LPS), all ordered to come up with policy actions which according to Law 17/2003, are not to be subject to specified limitation of 3% of GDP. In addition, it had also been the practice for BI in its market intervention to buy and sell securities only in the secondary market. This new law relaxed the 3% budget limit, allowing for BI to purchase government bonds on the primary market. Thus, the new law opens the door for the Government and Bank Indonesia to resort to mechanisms and means to adjust the regulation as deemed necessary. Obviously, the onslaught of the Covid-19 pandemic is considered an extraordinary circumstance and is thus a valid justification for the stipulation. The law also sets a time frame as temporary, up to end of fiscal year 2022, presumably when the pandemic is brought under control. 

As someone who was part of the team in charge of the policy responses to the onslaught of the devastating financial crisis of 1997/98, I may without hesitation state that the policy response facing the pandemic arguably poses an even bigger challenge than Indonesia faced before, and is commendable in terms of the synchronization and coordination, compared to the policy responses facing Global Financial Crisis of 2008, and definitely the 1997/98 Asian Financial Crisis. 

I would argue that even if subconsciously, the authorities and in fact the private sector also have learned from both the successes and failures of the past. This is especially true in this case, judging from how a coordination of policies has been constructed in a short time and enacted in synchronised regulations and in cooperation with the Parliament into law. 

On a personal note, had this type of regulation been there in 1997, my colleagues and I on the BI Board of Directors would not have had to face the humiliation of investigations, let alone a corruption trial in court, for the accusation and indictment for 3 of my colleagues for supposedly exceeding our authority. The court failed to prove anyone committed embezzlement or received bribes, the more common definition of corruption. Frankly, I am envious of the neat work put up in these programs with a regulation to base on to avoid any disputes in the futures about the legality of the policies taken. I am a strong believer in punishing corruption but at the same time fighting against criminalization of policy. Of course, this must be based solidly based on law and regulations. A policy that has been proven to be based solidly on law and regulations, enacted in good faith and with good intentions, should not be criminalized. These are legal problems; decisions must be based on everything that has been proven, not allegations, politics nor money. 

However, my discussion here and a previous one is more concerned with conceptual and theoretical underpinnings, a matter I think is worthwhile to discuss, to achieve a sharper understanding of the picture as a whole as well as possible implications or adverse impacts, even if only in the future. 

As we learn from our observation following the news, this novel Corona virus keeps revealing new characteristics that are previously unknown, starting from the asymptomatic nature of those carrying the virus, the new and unfamiliar damage that the virus causes, similar symptoms as heart conditions, the fact that it also attacks young children more or less similarly to adults, etc., etc. 

Likewise, it is true that there have been different impacts of economic phenomena that create new challenges to conventional wisdom in economics, like why has not the huge increase of liquidity globally caused any strong push on increasing prices and inflation as conventional theory predicts? 

Income Inequality and Quantitative Easing 

When the QE was introduced by the Fed back in 2008, through the purchase of Treasury bonds and mortgage-backed securities (MBS), the aim was to push long-term interest rates down in order to stimulate investment. Technically, the purchase of large amount of these securities by the Fed worked to push bond prices up, which would imply that yields or the return on investment in this instrument would decline. Thus, the interest rate on this investment would decline and this would stimulate investment spending to rise. 

A study conducted by Jonathan S. Hartley and Alessandro Rebucci showed quantitatively the effect of QE on lowering long-term interest rates in “An Event Study of Covid-19 Central Bank Quantitative Easing in Advanced and Emerging Economies” (NBER Working Paper 27339, June 20, 2020). The study used data from 21 countries, 8 developed and 13 emerging economies which had recently implemented QE. The study looks at the cases of the purchases by central banks of 10-year sovereign bonds for these groups of developed and emerging economies. In both groups the purchase did demonstrate a tendency to lead to lower interest rates. Also, the policy worked a bit stronger in emerging economies, possibly because this was the first time these countries had resorted to the policy. However, the study did not say anything about its impact on investment spending, and so the real sector. In any case, it is a welcome addition of means for emerging economies that so far has never been employed. 

Investment funds move between the two alternatives of bonds and equities or stocks, seeking the one that promises a higher return, between bond yield and return of investment on equities. With the QE bond yield moving downward this would cause investment funds to shift to equities, which would push stock prices upward. Generally, ownership of stocks is concentrated in the hands of high-income groups or the rich, while the poor do not hold any such instruments. It is also true that pension funds and savings of fixed-income earners are invested in sovereign bonds or fixed income. The QE, which was aimed at suppressing long-term interest rates, had the additional impact of raising prices of equities. As a result, the return on investment in equities had become better than the return of investment in bonds. In this way, QE, which is aimed at lowering long term rate of interest tends to effect income distribution adversely. (J. S. Djiwandono, “Income Inequality; New Worry Over Impact of QE”, RSIS Commentary, 11/11/2014). So, QE tends to hurt savers and due to the pattern of ownership and investment of different income groups it has been criticized for lopsidedly benefiting the rich at the cost of the poor, and thus increasing income inequality. 

When all countries globally face the Covid-19 pandemic, that shocked all inhabitants with both public health and economic crises, most countries tried their best to come up with policies addressing the problems arising from both crises. Indonesia is no exception, as alluded to above. In addressing the economic problems arising from or related to the pandemic, most countries implemented extraordinary fiscal stimulus. And due to limited fiscal space that these countries had been confined in, even prior to the pandemic, many countries also resorted to a new monetary policy to support the policy launched by the fiscal authority. 

The unequal distributional impact of QE implementation on income, which I referred to above, regards its implementation on developed economies. The question now is would the implementation of the policy in emerging economies, and more specifically Indonesia, also results in worsening income inequality? There has not been any study that I know of dealing with this matter, but it would be a surprise indeed if it were different. For sure, if QE does indeed worsen income distribution, we cannot ignore it. The problem of unequal income distribution has been a public concern in Indonesia for quite some time, as shown in the Gini coefficient, especially when it is measured in wealth, not income. 

Furthermore, in combination with the Covid-19 pandemic and the policy addressing it, the adverse impact of QE implementation on income inequality may even be stronger in emerging economies. Most reports showed that the victims of the Covid-19, in terms of the number of positive cases and deaths in most countries, revealed that the poor suffered more than the rich. And as if this is not enough, the unfortunate fact has been that the policy to cope with the pandemic has also been putting poor groups at more disadvantage. Whether total or semi lockdown with social distancing, wearing masks and washing hands requirements or others, has relatively burdened the poor more than others, since basically they are less fitted to live under such stringent requirements, imposed by the ongoing emergency of the pandemic. 

According to a study by Jayant Menon, “COVID-19: Balancing the Infection and the Misery Curves” ‘COVID-19 not only highlights existing inequalities, it exacerbates them. Not only do the poor have higher COVID-19 infection and mortality rates, they suffer disproportionately from curtailment measures. As governments try to flatten the infection curve, the misery curve measuring the loss of incomes, livelihoods and lives has been rising.’ (ISEAS Perspective, June 17, 2020) 


Issues that we should at least keep in mind include the importance of continuing to upgrade the management of our national economy, as it confronts increasing risks and uncertainties, a nexus of VUCA – Vulnerability, Uncertainty, Complexity and Ambiguity. I would start maybe with focusing more on the institutional arrangements of the policy package facing the pandemic, whether in the implementation all have been performing as well as hoped. In other words, reviewing their performances. For instance, the scheme of burden-sharing between the Government (Ministry of Finance) and Bank Indonesia, and the reliance on QE in conducting monetary stimulus. It is commendable, in facing currently extraordinary circumstances. Close monitoring and assessment of the implementation should be conducted to check whether there are implications that have been overlooked. Coordination and synchronization of policies should not be confused with encroachment of central bank independence, for instance. I never tire of stating that eclecticism should be encouraged, staying nimble and flexible, ready to make adjustments deemed necessary in the face of both external as well as domestically-originating dynamics, all part of this mysterious new normal. 

The new monetary policy is certainly a new and promising means, but it has its limits as well. The new monetary policy would result in the monetary authority being better-equipped in burden sharing with the fiscal authority. It could provide support to the fiscal authority when the country needs to address extraordinary challenges (like this pandemic) when fiscal space is confined. 

Monetization of debt is a smart technique in finance, but as some monetarists would claim, debt must never be considered an asset. The securitization which transformed claims of loan repayments into securities, and included the subprime loans as well, became part of the meltdown that later erupted into a global financial crisis. 

Monetary policy cannot and should not ever substitute for fiscal policy. When he was still President of ECB, Mario Draghi never quite reiterating that ECB could not do it alone (providing long-term refinancing operations or LTRO, which was how ECB implemented QE); the fiscal authority must step in. 

For Indonesia, this is even more relevant. For one, the sovereign rating must be guarded to at least remain the same. With a pandemic that is still not clear as to when it will be over, adverse effects on the national economy might well persist. Even getting back to a fiscal position prior to the pandemic, which was weak due to a low tax ratio, may need longer. Improving tax revenues may still take longer yet. Be that as it may, support from an accommodative monetary policy may still be needed for longer period. For sure, these are daunting challenges that both fiscal and monetary authorities are facing. Let us hope for the best.