What is Open Economy

This chapter aims to investigate the possible impacts of commodity and asset bubbles on inflation in Indonesian economics. The analysis is facilitated by a macroeconomic model described by a couple of structural equations which consist of several exogenous variables as shock generators. The model is basically a linear rational expectation model (LREM) and solved by implementing undetermined coefficient methods. A series of simulation based on the state space representation of the model with respect to an impulse response function is performed to highlight some of key features of current inflation trends. It is shown that consumer price inflation can be propagated by both hikes in international commodity prices and assets prices. Consequently, inflation can be more difficult to manage during an episode of commodity and asset bubbles. Indeed, such an episode is very common to emerging economies during the last few years and thereby it is not surprising that monetary authorities tend to miss the inflation target very often. It suggests that the authorities should take into account the future movement of commodity and assets prices when setting the target.