THE IMPACT OF MONETARY POLICY TOWARD INDONESIAN STOCK MARKET UNDER INFLATION TARGETING REGIME

A high volatility in stock market movement can be influenced by current news both domestic
and international economic shocks, including the ongoing global financial crisis that affect
Indonesian economy in particular. Based on empirical studies and theories, that monetary policy
can be an effective tool in order to stabilize the stock market volatility. Monetary policy can have a
significant effect on the movement in stock market. Does it really happen on Indonesian macro
economy? This paper investigates the relations between monetary policy by its instruments and
stock market movement. Our empirical evidence is based on before and after the adoption of
Inflation Targeting Framework, including the period of Asian Crisis (1997) and the Global
Financial Crisis (2008). This paper uses a Vector Error Correction Model (VECM) in order to
examine the dynamic movement and changes on Indonesian Stock Market as an impact of the
changes in monetary policy in terms of Inflation Targeting regime. Utilizing an Impulse Response
and Variance Decomposition approach, this paper analyzes the effectiveness of monetary policy
toward the stock market performance in order to achieve the stability of stock market and to
develop market expectations. These objectives are beneficial to strengthen the credibility of the
Central Bank as the monetary authority in terms of the implementation of Inflation Targeting
Framework. Furthermore, this paper attempt to assess and evaluate the monetary policy and
induce the central bank to create an optimal policy in the future.

Keywords: inflation targeting framework, monetary policy, stock market, vector error
correction, variance decomposition