Does the Credible Fiscal Policy Support the Prices Stabilization?

Issue: 2/2015

Haryo Kuncoro

Faculty of Economics, State University of Jakarta, Indonesia, e-mail:

This paper aims at analyzing the co-movement between fiscal policy and monetary policy rules in the context of price stabilization. More specifically, we observe the potential impact of fiscal policy credibility on the price stabilization in the inflation targeting framework. Motivated by the fact that empirical studies concerning this aspect are still limited, we take the case of Indonesia over the period 2001-2013. Based on the quarterly data analysis, we found that the impact of credibility typically depends on characteristics of fiscal rules commitment. On one hand, the credibility of debt rule reduces the inflation rate. In contrast, the incredible deficit rule policy does not have any impact on the inflation rate and therefore does not support to inflation targeting. Given those results, we conclude that credibility matters in stabilizing price levels. Accordingly, those findings suggest tightening coordination between monetary and fiscal policy to maintain fiscal sustainability in accordance with price stabilization policy.

DOI: 10.1515/revecp-2015-0014
JEL: H62, E63, E58, E52
Keywords: Inflation Rate, Fiscal Rules, Deficit, Debt, Credibility