Bank Indonesia Floating Exchange Rate Case Study
Exchange rate is the value of a currency in terms of another, it is determined by the demand for and the supply of currencies on the foreign exchange market. There are three exchange rate systems commonly used; fixed exchange rate, floating exchange rate, and managed exchange rate. At first, Bank Indonesia had adopted a managed float exchange rate system for Rupiah back in 1978—so it was floating in the market. But Bank Indonesia decided to change the system by intervening in the open market operation.
In a floating exchange rate, the value is determined by the market forces e.g. demand and supply of the currency in the foreign exchange market, and there is no government intervention. Any change or shift in the demand and supply leads to a change to Rupiah. With this system, there are factors affecting the Rupiah; relative interest rates—higher rates currency appreciates, rise in domestic income relative to incomes abroad that make Rupiah goes down, demand of imports and exports, investment opportunities, speculative sentiments, global trading patterns, and changes in relative inflation rates.
Where in a managed exchange rate, Bank Indonesia combines the elements of both fixed and floating systems. There surely is the
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This happens on a regular basis under a flexible exchange rate system. A central bank would go over an almost-impossible goal and try to reverse an established market trend, but fails the attempt in the end of the day. There are factors that cause the central bank to intervene; excessive exchange rate fluctuations, and negative impact on economic activity from the exchange rate fluctuations. The first factor mentioned is only to imply and highlight the behavior of exchange rates. And the second factor is that the exchange rate might negatively affect international trade and investment because of its
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