Time-Variant Sources of Inflation and Inflation Volatility, Their Interrelations and Effects on Macroeconomic Fluctuations: Evidence from Indonesia and Thailand
Indonesia and Thailand, two major open economies in Southeast Asia operating under managed-float exchange rate systems, have remained susceptible to both external and domestic shocks since the East-Asian financial crisis of the late 1990s. This paper investigates the transmission of external shocks to these economies via their impact on inflation and inflation volatility. The paper attempts to answer a question. How significant are external shocks, relative to domestic shocks, as drivers of inflation and inflation volatility? In both economies, inflation is more sensitive to external shocks relative to domestic shocks consistent with the inflation globalization hypothesis while inflation volatility is sensitive to both external and domestic shocks. Inflation and inflation volatility are found to have a feedback relation between them, consistent with the Friedman‐Ball and Cukierman‐Meltzer propositions. They drive the real exchange rate up while adversely affecting output and asset prices.