Credible Fiscal Policy and Exchange Rates Stabilization

Abstract

This paper aims at analyzing the potential impact of fiscal policy credibility on the exchange rates stabilization. Motivated by the fact that empirical studies concerning this aspect are still limited, we take the case of Indonesia over the period 2001-2013. Based on the quarterly data analysis, we found that the impact of credible fiscal policy typically depends on characteristics of fiscal rules commitment. In one hand, the credible debt rule policy reduces the exchange rate fluctuation. In contrast, the deficit rule policy – which is incredible – does not have any impact on the exchange rate and thus does not support to the exchange rates stabilization. Given those results, we conclude that credibility matters in stabilizing foreign exchange market. Accordingly, improving the credibility of fiscal policy should be an integral part of the exchange rates stabilization program. Keywords: