RESPONSE OF EXCHANGE RATE TO MONETARY POLICY SHOCKS: AN EVIDENCE FROM INDONESIA

Abstract

The exchange rate is a significant determinant in shaping the direction of monetary policy. This study examines the exchange rate reactions to monetary policy shocks in Indonesia from 2005 to 2021 using a vector autoregression model to capture the influence of monetary policy on the exchange rate. The results demonstrate that the exchange rate responds positively to interest rate, money supply, and inflation shocks. In contrast, exchange rates respond negatively to reserve shocks. Since we employ structural vector autoregressive, our findings are consistent with the actual result. In addition, we incorporate the actual exchange rate as opposed to the nominal exchange rate used in the baseline model. The outcome is still comparable to that of the baseline model. The consequence is that a rise in interest rate, money supply, and inflation results in a depreciation of the exchange rate, whereas an increase in reserves results in an appreciation.