The Effectiveness of Inflation Targeting in Mitigating The Impact of World Oil Prices and Exchange Rates on Inflation in Indonesia: an ARDL Approach

Abstract

Although Bank Indonesia has embraced Inflation Targeting (IT) since 2005, Indonesia's Inflation remains subject to exogenous shocks, particularly oil price volatility and exchange rate instability. This study considers the role of IT in (i) mitigating transmission of external shocks to domestic Inflation, and (ii) what is new is the interaction terms between IT and oil prices and exchange rates features that have not been examined previously in the Indonesian setting. Annual time-series data from 1990 to 2024 are used in this study. Inflation, Brent crude oil prices, the IDR/USD exchange rate, the BI Rate, the broad money supply (M2), the IT dummy variable, and two interaction factors are all included in this research using the Autoregressive Distributed Lag (ARDL) method. The findings demonstrate that exchange rate depreciation significantly raises Inflation, and the interaction term between IT and exchange rate is negative, indicating that IT partially reduces the pass-through effect. On the other hand, the interaction term between IT and oil price is positive and statistically significant, indicating that IT has failed to control oil price-induced Inflation. In general, Indonesia's IT is ineffective, suggesting that stronger monetary-fiscal collaboration is required to preserve price stability. Limitations include the annual periodicity of the data, the lack of clear inflation forecasts, and the single-country scope, which caution against generalizing the findings.Keywords: Inflation, Inflation Targeting, Brent Crude Oil Price, Exchange Rate,        Money Supply