Two American economists, Maurice Obstfeld of the University of\nCalifornia, Berkeley and Kenneth Rogoff of Harvard University, have long\nbeen references in international macroeconomic studies. In their highly\npopular article entitled \u2018The Six Major Puzzles in International\nMacroeconomics: Is There a Common Cause?\u2019, they identified six main\npuzzles in international macroeconomics. One of these puzzles, relevant\nto the phenomenon of the extreme depreciation of the rupiah against the\nUS dollar, is the home bias puzzle. Home bias is defined as the tendency\nof investors to invest in their own country\u2019s assets, even though\nholding another country\u2019s assets could yield higher returns. Since the\n1990s through the early 2000s, approximately 94 per cent of US investors\ninvested in their own country\u2019s assets. This home bias puzzle can also\nexplain why monetary models for determining exchange rates using\nfundamental factors become inaccurate in predicting exchange rate\nmovements.<\/p>\n
This is reminiscent of the question posed by Queen Elizabeth II\nduring a visit to the London School of Economics (LSE) in November 2008.\nThe Queen challenged the esteemed economists at LSE regarding the\ndevastating 2008 financial crisis, the largest in history. Her question\nwas simple yet profound: \u2018Why did no one see the financial crisis\ncoming?\u2019 This question subsequently became a main headline for global\nmedia outlets such as The Guardian, The Telegraph and The New York\nTimes. The frequency of financial crises has increased, and not one of\nthese crises could be precisely predicted by economists. Economic\nprojection models were expected to be like weather projection models\nthat can determine when rain or sunshine will occur. Economists and\neconomics must fundamentally reform. As a result, until her passing,\nQueen Elizabeth II never received an answer to her question from\neconomists. This aligns with a lecture by Nobel Prize-winning economist\nPaul Krugman at LSE entitled \u2018Crisis in the Economy and Economics\u2019. This\nlecture was later published in the globally popular, London-based\nmagazine The Economist, with an article titled \u2018Dismal Science\u2019.<\/p>\n
The same point was emphasised by senior US economist Ben Bernanke\n(2009), who stated that economists must work with highly complex systems\n(economic models) because the economy faces random pressures, limited\ndata availability and perpetually imperfect knowledge. Mathematician and\nmeteorologist Edward Lorenz (1917-2008) introduced the term \u2018butterfly\neffect\u2019. In making projections, even the smallest change in the initial\ncondition will affect the projection results. For example, the monetary\nmodel for predicting exchange rates using fundamental factors is the\nmost popular and widely used by policymakers. This approach has been the\ndominant paradigm from the 1970s to the present.<\/p>\n
The monetary exchange rate projection model is based on two main\nbuilding blocks: the condition that Purchasing Power Parity (PPP) and\nUncovered Interest Rate Parity (UIP) hold. The exchange rate is\nexpressed as the difference in prices and interest rates between two\ncountries. The change in the rupiah per US dollar exchange rate depends\non the difference in inflation (changes in the Consumer Price Index)\nbetween Indonesia and the US. A rise in US inflation causes the rupiah\nper US dollar exchange rate to strengthen. Conversely, a rise in\ninflation in Indonesia causes the inflation differential between\nIndonesia and the US to increase, which causes the rupiah per US dollar\nexchange rate to weaken. In recent months, the rupiah per US dollar\nexchange rate has weakened from Rp 16,669.8 per US dollar on 1 January\n2026 to Rp 18,161 per US dollar on 10 June 2026.<\/p>\n
The fluctuation of the rupiah per US dollar exchange rate also\ndepends on the interest rate differential between Indonesia and the US.\nIndonesia\u2019s interest rate is measured by the Bank Indonesia (BI)\nreference rate, called the BI rate. The US interest rate is measured by\nThe Fed policy rate, the Federal Funds Rate (FFR). An increase in the\nFFR causes the interest rate differential between Indonesia and the US\nto rise. The expectation of rupiah depreciation against the US dollar\nalso increases. Therefore, to reduce pressure on the rupiah per US\ndollar exchange rate, an FFR increase will be followed by an increase in\nthe BI rate. The hope is that depreciation expectations will\nsubsequently decline.<\/p>\n
In short, according to Meese and Rogoff (1983a), the fluctuation of a\ncurrency\u2019s exchange rate depends on several macroeconomic indicators\ncommonly referred to as fundamental factors. If the fundamental factors\nare poor, the exchange rate weakens. Conversely, if the fundamental\nfactors are good, the exchange rate strengthens. This means the\nfluctuation of the rupiah per US dollar exchange rate is determined by\nthe difference in money supply growth, economic growth, interest rates,\nbalance of payments and inflation between Indonesia and the US. In fact,\nat a time when the rupiah\u2019s fundamental conditions are sound, the rupiah\ncontinues to weaken against the US dollar. The phenomenon can be caused\nby home bias behaviour, which triggers a net outflow of foreign capital\nfrom domestic financial instruments. Home bias behaviour then triggers\nextreme depreciation of the rupiah per US dollar, pressures the Jakarta\nComposite Index and causes the price of government bonds to fall (with\ntheir yields rising).<\/p>\n
What steps can the government and Bank Indonesia take? First,\neliminate information asymmetries among market participants, making the\ncost of seeking and processing information very low. Second, remove\nregulatory barriers to investing in various domestic financial\ninstruments, ensuring no different rules apply.<\/p>", "url": "https:\/\/jawawa.id\/newsitem\/the-home-bias-phenomenon-and-extreme-rupiah-depreciation-1781153592", "image": "" }, "sponsor": "Okusi Associates", "sponsor_url": "https:\/\/okusiassociates.com" }