Analyzing the Relationship among Inflation, Money Supply, Exchange Rate, and Lending Interest Rates in Indonesia: A VECM Approach (1989–2024)

Abstract

This study aims to analyze the relationship between inflation, money supply (M2), exchange rate, and lending interest rate in Indonesia during the period 1989–2024. Using the Vector Error Correction Model (VECM) approach, the research examines both the short-term and long-term relationships among these monetary variables. The study employs annual secondary data obtained from the World Bank (World Development Indicators). The Johansen cointegration test results indicate the existence of four cointegrating equations, implying a long-run equilibrium among the variables. The VECM estimation results reveal that in the long run, money supply and lending interest rate significantly influence inflation, while the exchange rate has an insignificant effect. In the short run, inflation is affected by its past values and money supply, whereas the impacts of exchange rate and lending interest rate are statistically insignificant. The Impulse Response Function (IRF) analysis shows that inflation responds strongly to shocks in money supply, while responses to exchange rate and interest rate shocks are temporary. Meanwhile, Variance Decomposition results suggest that, in the long run, fluctuations in inflation are primarily explained by variations in lending interest rate and money supply. These findings highlight that monetary factors play a crucial role in determining inflation dynamics in Indonesia.