Vector Error Correction Model to Analyze the Impact of Exchange Rates and Money Supply on Inflation in Indonesia

Abstract

This study analyzes inflation in Indonesia in relation to the influence of exchange rates and the money supply (M2), which pose challenges in controlling inflation amidst rapid economic growth. Data from the Ministry of Trade of the Republic of Indonesia (Kemendag) were used to investigate the relationship between exchange rates and the money supply (M2) on inflation using the Vector Error Correction Model (VECM). The results indicate that in the short term, inflation tends to decrease towards stability, with a strong exchange rate capable of reducing inflation, while an increase in the money supply slightly raises inflation. However, in the long term, inflation demonstrates a strong self-correction mechanism, with the influence of exchange rates and the money supply becoming limited. This model proves effective in forecasting inflation for the period from March to August 2024, with a Mean Absolute Percentage Error (MAPE) of 19.59%.