Macroeconomic stability? By what definition?

Macroeconomic stability? By what definition?

D.A. Simarmata, School of Economics, University of Indonesia, Jakarta,
matabm@centrin.net.id

Macroeconomic stability are some of the most frequent words
heard today, either from officials or from those in business.
Surprisingly, they add a contradictory term to that: High
unemployment. This is a contradiction because the word
"macroeconomic" includes the employment rate, which should be at
an acceptable level, say 4 percent to 5 percent.

Most governments prioritize employment, the continuity of
their government being at stake. Full employment is the dream of
all societies, which is usually expressed in their political
platforms. But in this country, full employment is easily
discarded from the government's priority list, it, without
hesitation, triumphantly stating the achievement of macroeconomic
stability despite rampant unemployment. Are the academics in the
government ignoring the basic definitions of macroeconomics? Is
it pleasantry or just intended ignorance?

In referring to a book written by Dornbusch, Fischer and
Startz, one finds a series of issues regarding macroeconomics --
the economy as a whole -- covering the topics of gross domestic
product (GDP), inflation and unemployment rates, balance of
payments, interest rates, exchange rates, current account, and so
on.

By aiming for macroeconomic stability, all the macroeconomic
variables should lie within an acceptable range of values. The
role of employment in any economy is decisive for the
determination of GDP.

By following "Okun's law", each 1 percent additional
unemployment rate reduces the GDP by 2 percent. Or, stated
otherwise, each reduction of 1 percent in unemployment will raise
2 percent of GDP. If the unemployment level is assumed to be 15
percent, then by reducing it to 5 percent, the GDP will rise by
20 percent.

This is a very large amount, in the order of Rp 300 trillion
approximately, and would bring in a large amount of income tax
for the government. Besides, all economic efforts should be
directed to serving human beings. One of the basic needs for
human beings is to have a workplace, matching her or his ability.
This is a basic human right. So, this should be a matter of
utmost importance for any government, including the Indonesian
one.

Law no. 23/1999 on the Indonesian central bank assigns Bank
Indonesia to maintain the stability of prices. The central bank
has interpreted the task in its work program as achieving a low
level of inflation.

From a multiple-objective function imperative, the central
bank law has reduced it to a narrow, single objective, forgetting
the objectives of full employment. This is a very significant
drawback in the law, compared even with the frequently cited
Bundesbank law, an exemplary independent central bank all over
the world. But the Bundesbank is obliged to support the German
Federal Government to achieve full employment. This is now done
in concert with the European Central Bank (ECB).

The Indonesian central bank is intensively working on the
intellectual basis for practical direction of the inflation-
targeting instrument. The concept was originally employed in the
New Zealand central bank, now in vogue in many countries.

But the instrument has been under attack from many sides. Some
economists in India talk about the inappropriateness of the
method for them, because the basic concept of core inflation used
in the model does not take into account the volatility of the
price of food and many other basic necessities. These goods are
vital for the lives of the majority of the people.

By neglecting them in monetary management, it is equally
neglecting the needs of the people in the country. So what is the
purpose of the central bank?

There is also another peculiar thing in law No. 23/1999, in
that the central bank is not considered to be part of the
government. It is independent, so the central bank has no
obligation to support the overall objective of the government,
namely to reduce the unemployment rate. What a chaotic concept!

Paul Volcker, the Federal Reserve (Fed) chairman before Alan
Greenspan, stated that the central bank was part of the
government. The Fed is independent within the government. And,
the president of the US has the right to replace the Fed
chairman, if he considers it necessary. President Clinton once
considered replacing Alan Greenspan, but decided not to do so due
to fears of the probable consequences on financial markets.

Greenspan has such high credibility that any attempt to
dismiss him could destabilize the market. As a mater of fact,
Greenspan is a member of the Republican Party while Clinton is a
Democrat.

The limited task of the central bank for maintaining stability
in prices should be revised, which means revising Law No.
23/1999. Controlled inflation, which was below 10 percent before
1997, should remind us that low inflation is not a guarantee
against financial crisis.

A recent study showed the occurrence of financial crisis amid
a stable macroeconomic situation (not in the above Indonesian
sense).

Latest data on the Indonesian economy shows that the
utilization rate of the installed capacity is 40 percent to 50
percent. On the other side, the lending to deposit ratio (LDR) of
banks is approximately at the same level, around 50 percent. Such
a high level of idle capacity is a sign of economic depression.
Hence, an increase of one percent in GDP does not necessarily
require a normal ICOR, say 5 to 5.5.

Industry needs only working capital, which should be much less
than if it included new investment. At this state of the economy,
the ICOR could lie in the range 2 to 3. But alas, Bank indonesia
only concerns itself with the IT concept, and the government is
busy with the ICOR concept, arguing about the absolute necessity
of new investment. Unfortunately, both proclaim macroeconomic
stability, despite high unemployment rates. What a big lie!