Christopher Lingle, Bangkok
Forecasting the course of an economy has a lot in common with supernatural methods that pretend to offer a window into the future. When tealeaves are read, an eye is cast at what appeared in the past in order to divine unseen events.
Similarly, existing economic data are used as an indicator of what should follow based upon a number of subjective assumptions and interpretations. Given this subjectivity, techniques of economic data analysis tend to be as arcane and unreliable as methods of fortune telling. And so there should be doubt about what economists predict.
Of course, there is better accuracy in events that unfold in the near future. For example, the consensus forecasts for the full-year growth rate for 2007 of Indonesia’s economy of 6.2 percent, the fastest since 1996 when the rate was 7.8 percent may be on target.
But forecasting economic conditions at greater remove from the present involves much greater risks just as it does in weather forecasting. That means that greater uncertainty must be attached to the forecast for the rate of economic growth in 2008 by the Indonesian government that is in the range of 6.4 to 6.7 percent.
Since conjuring up an overall outlook of Indonesian economy for 2008 cannot be done in isolation, it turns out that this might be wishful thinking. A forecast by Organization for Economic Cooperation and Development suggests that 2008 will herald slower growth for the global economy at the lowest rate in five years.
Meanwhile, Indonesia economy will be influenced by knock-on effects of the sub-prime mortgage turmoil in the U.S. and higher international commodity prices. Indonesia produces the most oil and gas in Southeast Asia but is faces the pain of being a net oil importer with prices far above the budget assumption of $60 per barrel.
Of course, there are bright spots given the strong global demand for key commodity exports like coal, palm oil, and rubber along with a mild resurgence of tourist arrivals. And as the biggest exporter of coal for power plants, rising prices could boost Indonesia’s economic growth over the coming year.
The outlook on Indonesia’s economy for 2008 offered here will dwell less on past data that on the effects of current policy on quantitative and qualitative growth prospects.
Unfortunately, the good news for the local economy has been undermined by step taken by Bank Indonesia (BI). A cut in the benchmark BI rate to 8 percent in recent weeks, the 14th since May 2006 for a total decline of 4.75 percentage points, it is the lowest rate since being introduced in 2005.
Following economic orthodoxy, BI justified the latest rate cut on reported easing of upward pressure on prices. Apparently, the consumer price index (CPI) rose 0.18 percent in November over October, up 6.71 percent from a year earlier. This put it at the lower end of forecasts. The year-to-year core CPI measure that removed the effect of food and energy prices was up in November to 6.25 percent, up from 5.66 percent in August.
Given that the CPI was 12 percent in late 2005, many commentators give high marks for the recent inflation-to-economic-growth track record. Such praise is misplaced because Bank Indonesia’s monetary policy has done immense harm to long-term economic growth prospects.
In the first instance, the current rate of price increases would cause the price level to more than double in less than 10 years. But the actual effect of higher prices for the man on the street is likely to be much higher and come much more quickly. This is because of the tendency for government officials to underreport inflation estimates.
Since CPI reveals rising prices that are fundamentally caused by expansionary monetary policy, there is a tendency to underestimate these numbers. As such, central bankers and finance ministries have an incentive to underreport inflation, they also tend to obscure the true cause of inflation, pumping up the money supply.
For example, blame for inflation is often diverted to supply disruptions or higher demand for goods. The current scapegoat is higher oil prices or the ravenous appetite of the Chinese economic machine that is devouring prodigious amounts of commodities.
But demand alone cannot push up the general level of prices unless there is loose monetary policy to pump in more credit or freshly-printed money. If the money supply remained under tighter control, the increase in some prices would require an offsetting decline in other prices. And so it is that the blame for the damage from overall increases in the general trend of prices lies squarely with those in charge of monetary policy.
It is important to note that the harm from a general rise in prices hits only some groups of people while others will be unaffected and others reaping benefits. This is because all prices will not rise at the same rate. As such, inflation always has a bigger impact on the production and consumption of some goods more than others.
It turns out that loose monetary policy tends to redistribute income and wealth from the poor to the rich and from the weak to the strong. In particulars, it causes a decline in the real incomes of pensioners and low-income earners that consume most of their income.
Such economic injustice is bad enough. But rising price levels cause widespread damage to the overall economy by encouraging speculative buying and resource misallocation.
Bank Indonesia operates under a mistaken belief that economic growth can be fine-tuned or conjured up by fiddling with interest rates. The so-called BI rate operates as a reference for bank rates and bill sales.
In lowering the BI rate, it is hoped that banks will lower their rates and lend more to households and businesses so that higher consumption and investment can boost growth. But lower interest rates cut two ways. As commercial banks lower deposit rates, some saving is discouraged so there will be a lower stock of real savings from long-term income needed for sustainable economic growth.
It is also thought that lower interest rates bring greater optimism that acts as a stimulus to the real sector of the economy. While this is a common belief among mainstream economists, it is pie-in-the-sky nonsense.
Consumers or business leaders may be tricked into being more confident through false signals created by increased government spending or artificially-low interest rates. But new borrowing or investment inspired by artificial and temporary stimuli that will dry up or be reversed leads to unfulfilled future expectations.
This reversal and drying up of policy-induced stimulus is inevitable since it eventually leads to rising consumer prices. And then liquidations of ill-advised investments must occur that pushes up unemployment and slows down the economy.
Happily, there are better policy approaches to set the stage for higher sustainable economic growth. In particular, the Indonesian government can improve the overall business environment to inspire restructuring, increase productivity and reduce restrictions on commerce. Such steps are the best way to soften the unavoidable pain of restructuring and liquidations set into motion by ill-advised monetary and credit policy of Bank Indonesia .
The writer is Research Scholar at the Centre for Civil Society in New Delhi and Professor of Economic at Universidad Francisco Marroquin in Guatemala. He can be reached at Clingle@ufm.edu.gt.
