Transmission Mechanism on Dual Monetary System in Indonesia: Comparison Between Shariah and Conventional Instruments

Aam S. Rusydiana

Abstract

The transmission mechanism of monetary policy has been an area of abundant economic research in many countries. The financial system links monetary policy and the real economy. Thus, events or trends that affect the financial system can also change the monetary transmission mechanism. This study tries to analyze transmission mechanism in Indonesian dual monetary system, using Vector Auto Regression (VAR) and Vector Error Correction Model (VECM) methods.

Results show that the relationship between LNIHK and shariah instruments: financing (LNFINCG), SBIS and PUAS is negative. It means, when the total of shariah financing be increase, it will gives positive contribution for reducing inflation rate in Indonesia, because with this system possibility to make equal growth among monetary and real sectors appears. Therefore, it will be strategic action for monetary authority to grow up shariah banking share in Indonesia, for minimizing ‘bad inflation’ in economy.

JEL Classification: C32, E31, E42, E52
Keywords: Transmission Mechanism, Dual Monetary System, Shariah Instruments, VAR/VECM

1. FOREWORD
1.1. Background
The problem on money is a complex one. It relates to almost every aspects in economic. Because of that, the process in making monetary policy that can get through real sectors becomes a complex problem too. This process commonly known as transmission mechanism on monetary policy. This mechanism is a channel between monetary policy and economics (Pohan, 2008). Bernanke and Gertler stressed on credit channel, while Obstfeld and Rogoff stressed the concepts of transmission mechanism on value exchange policy (McCallum in Hardianto, 2004). Some economists agreed that transmission mechanism is a process between the cause of changing real GDP and inflation through monetary policy mechanism.

Monetary authority in Indonesia, Bank Indonesia, uses interest rate instrument (SBI) in open market to influence the demand of loan which at last influence aggregated demand. Monetary transmission mechanism by interest rate start from short term rate to medium and long term rate (Warjiyo, 2003). When tight money policy is in use, the increase of interest rate will make banking-related sectors decreasing due to price lifting.

The increase of interest rate soon followed by decreasing in banking-related sectors because lender’s risks is increasing while lender’s income is decreasing. In other condition, uncompleted substitution between bonds and loan will make both instruments become coexisting to each other.

It happens because lender’s risks is increasing and lender’s income is decreasing. In condition where uncompleted substitution happens between bonds and loan, both instruments become coexistence to each other. Even so, the increase of interest rate doesn’t change lender’s business pattern from investments into bonds. In other condition, tight money policy will swing lender’s pattern of business from risky loan to safe bonds which soon followed by decreasing of aggregated demand because investors or lenders cut off their investments (Hardianto, 2004)

Since 1992, when the first shariah banking in Indonesia, Bank Muamalat, was established, there are dual banking system: interest rate system and free interest rate system. It was marked by the forming of SWBI (Wadiah Certificate of Bank Indonesia) instrument. This instrument base on the concept of profit sharing that gives flexibility to lenders in it. With this system, the increase of money in market will followed by the increase of real sectors.

It is possible that he existence of profit sharing system will swing consumer from interest rate to free interest rate system. Nevertheless, this mechanism substitution will also influence monetary policy and reduce negative effects due to loan decreasing in conventional system as impact of loan increasing in free interest rate system that balances the growth in monetary sectors and real sectors. They’ll all add shariah loan proportion in economics which give pressure on inflation rate.

This paper tries to identify monetary transmission process in Indonesia, which applies dual monetary system, by comparing financing and credit in conventional banking. It tries to prove whether shariah financing mechanism, especially in production, is capable of balancing the growth monetary and real sectors to keep inflation rate low. It also tries to measure the shariah monetary instruments’ effectiveness in generating real sectors.