Monetary policy rules for Indonesia: which type is the most efficient?

Purpose – The purpose of this paper is to evaluate the performance of six types of policy rules applied for Indonesia, using monthly data spanning January 1980 to December 2008. Design/methodology/approach – This paper uses deterministic simulations on a small macro model and evaluates the policy rules based on the loss function. Findings – Among six types of policy rules, an inflation forecast‐based rule with contemporaneous output gap (IFBG) is found to be the most efficient rule for Indonesia. The rule suggests that the central bank should react strongly to inflation deviations from the target, react moderately to the output gap and smooth the interest rate. The optimal horizon is 3‐4 quarters. Including the exchange rate in the policy rule causes deterioration in economic performance. Originality/value – No previous study examines Indonesia employing the same methodology.