Long-term Analysis of Inflation, Exports and Exchange

Rate of Economic Growth in Indonesia

Cut Putri Mellita Sari

, Devi Andriyani

, Irfan

, and Khairawati

Faculty of Economic and Business, Universitas Malikussaleh, Aceh, Indonesia

STIE Lhokseumawe, Aceh, Indonesia

irfanelmatris@gmail.com,khair_ira@yahoo.co.id

Abstract. Economic growth is one of the macroeconomic indicators that show

the level of welfare of a country. The factors that effect to economic growth is

inflation, exports and Exchange Rates. This study aims to analyze the effect of

Inflation, Exports and Exchange Rates to Economic Growth in the long run. Data

collecting used documentation. Data were analyzed using Vector Error

Correction Model (VECM) and cointegration test. The results of the study were

(1) there is In the short-term estimation only inflation affects economic growth

while exports and the exchange rate have no short-term effect on economic

growth. The most important thing from the short term equation is the value of

error correction. Error Correction coeficient of -0.733053. This shows that the

imbalance in economic growth in the current year (2018) will be corrected in the

following year by 73.3053%. and (2) there is a long term effect of variabels

inflation, exports and exchanger rate to economic growth in Indonesia in 1988-

2018. Based on the long-term analysis of the VECM model it is found that

inflation and exports negatively affect economic growth. While the exchange rate

variable has a positive influence on economic growth. the results of the analysis

of an increase in inflation of 1% will have an impact on the decline in economic

growth of 3.73178%.export variable has a negative influence which explains that

an increase in exports of 1% will reduce economic growth 3,65662%.

Keywords: Long term · VECM · Cointegration

1 Introduction

Globalization can be interpreted as the opening gate of intertwining cooperative

relations between countries with other countries. Integration process between countries

which occur on a global scale which subsequently occurs the existence of globalization

of production as well as market globalization. Market globalization Stop the merger of

previously separate national markets become a global market with a large choice [1].

Market globalization is also the globalization of production which createsthe existence

of international trade between countries. The economy is one of the main foundations

in a country's strength. But economic stability does not always run smoothly because

there are many factors such as inflation, export and exchange rate.

Inflation is the tendency of prices to increase generally against groups of goods needed

by the community and is continuous that efect economic growth. Inflation also affects the

economic growth that finally affect to the exports[2]. According to keynes inflation is an

Sari, C., Andriyani, D., Irfan, . and Khairawati, .

Long-term Analysis of Inﬂation, Exports and Exchange Rate of Economic Growth in Indonesia.

DOI: 10.5220/0010435300002900

In Proceedings of the 20th Malaysia Indonesia International Conference on Economics, Management and Accounting (MIICEMA 2019), pages 425-433

ISBN: 978-989-758-582-1; ISSN: 2655-9064

425

increase in the average price level, what is meant by prices in this case namely the price

of exchanging money for goods / services [3]. Inflation is one of the classic problems in

an economy that can result in a decline in real income of the community which has a

negative impact on the macro economy on an ongoing basis. This puts the issue of

inflation as a very important indicator in maintaining economic stability. The monetary

crisis that emerged in mid-1997 has caused a surge in inflation in Indonesia which has an

impact on the decline in purchasing power and a decline in economic growth.

These developments have placed inflation as a strategic indicator for efforts to

exclude the national economy from a prolonged recession. Until now, various efforts

have been made by the government both through controlling inflation from the

monetary side by Bank Indonesia as the monetary authority, as well as the

disinflationary policy on the aggregate supply side related to the production side.

In relation to monetary policy, one of the most important factors for the effectiveness

of monetary polic International trade is trade between countries which includes export-

import activities [4]. The purpose of trade activities is to improve the welfare of the people

of a country, because in international trade activities all countries compete in the

international market. International trade is a form of economic cooperation between two

or more countries provide immediate benefits. The form of cooperation between countries

can be in the form of export activities. The increase in Indonesian exports has a very

important significance for the economy of Indonesia. Besides being able to stimulate the

national production, the increase in exports could increase the employment and the

foreign-exchange revenues, mainly the US dollar. The increased revenue dollars to the

Indonesian economy will increase the Indonesian foreign exchange reserves and will give

impact on the strengthening of the rupiah against the US dollar [5].

The exchange rate is the value of one country's currency into another country's

currency. Different economists argue that a flexible exchange rate is considered an

important factor for any economy. [6]Moffett et al. (2017) group exchange rates into

four types. The exchange rate is still controlled by the government, which uses the

country's reserves for a certain period of time. The floating exchange rate that is

managed is the rate based on the demand and supply of certain currencies under certain

interactions from the government. A free floating exchange rate is an exchange rate that

is entirely dependent on the strength of supply and demand on the open market, without

government interaction. The last type of exchange rate is the exchange rate pegged -

when the local currency is pegged compared to other countries 'currencies, and the two

countries are similar compared to other countries currencies.

Macroeconomic variables of inflation, exports and exchange rates are determinants

that affect economic growth. Economic growth in Indonesia has been very volatile.

During the 1998 monetary crisis, Indonesia's economic growth slowed to -13.33%. Is

this volatile and slow economic growth affected by inflation, exports or the exchange

rate in the long run? This is what underlies the authors to examine further about the

long-term effects of inflation, exports and exchange rates on economic growth.

2 Literature Review

Economic growth is a process of increasing per capita output in the long run [7]. This

understanding covers three aspects, namely: process, per capita output and long term.

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Reflecting the dynamic aspects of an economy developing or changing over time.

According to Sukirno[8] economic growth is a means of measuring achievement from

an economic development.

In a macroeconomic analysis the level of economic growth to be achieved by a

country is measured by the development of real national income achieved in a given

year. Gross Domestic Product (GDP) is total national income and total expenditure on

output of goods and services in a given period. This GDP can reflect economic

performance, so the higher the GDP of a country, it can be said the better the economic

performance in that country. According to Keynes's theory, GDP is formed from four

factors that positively influence it, these four factors are consumption (C), investment

(I), government expenditure (G), and net exports (NX). The four factors are again

influenced by various factors, including those influenced by factors such as income

levels, price levels, interest rates, inflation rates, money supply, exchange rates.

Putong [9] says that "inflation is the process of increasing general prices

continuously". While the opposite of inflation is deflation, which is a continuous decline

in prices, as a result the purchasing power of the community increases, so that in the early

stages of goods become scarce, but in the next stage the number of goods will be more

and more due to the reduced purchasing power of the people. Inflation can cause

disruption to economic stability in which economic actors are reluctant to speculate in the

economy. In addition, inflation can also worsen the level of public welfare due to the

general decline in public purchasing power due to rising prices. In addition, the

distribution of income is getting worse because not everyone can adjust to inflation.

Inflation has positive impacts and negative effects depend on whether or not inflation is

severe. If inflation is mild, it has a positive influence in the sense that it can encourage a

better economy, which is to increase national income and make people eager to work,

save and invest. plummeted and plummeted over time. In general, inflation can result in

reduced investment in a country, encourage an increase in interest rates, encourage

speculative capital investment, failure of development, economic instability, a balance of

payments deficit, and a decline in the level of life and welfare of the people.

According to Mankiw [4] , exports are defined as exports goods / services produced

domestically can then be sold out country. For countries that have implemented an open

economic system, then the country will interact with other countries' economies

throughout world freely. One of the activities of economic interaction international is

to export goods and services. One of the benefits of exports is to look for new market

shares when the domestic market is already too saturated by competitors. Viewed from

the side expenditure, exports become one of the most important factors for the GNP, so

if the value of exports changes so the people's income also it will immediately change.

On the other hand, the high exports of one country will cause the country's economy to

be very sensitive shocks or fluctuations that occur in the market international / world

economy. Trade is a process of exchanging goods and services which is carried out on

the basis of like and like, to obtain the goods needed. In the period of globalization,

trade is not only conducted in one country. Even the world has entered free trade. There

is hardly a single country that has no relations with other countries [10]. Export is an

effort to sell commodities that we have to other nations or foreign countries with

government provisions by expecting payment in foreign currencies, as well as

communicating in foreign languages. So the results obtained from exporting activities

are in the form of a sum of money in foreign currency or commonly referred to as

foreign exchange which is also one of the sources of state income. What is meant by

Long-term Analysis of Inﬂation, Exports and Exchange Rate of Economic Growth in Indonesia

427

exports is trade activities that provide stimulation to grow domestic demand which

causes the emergence of large factory industries, together with stable political structures

and efficient social institutions [11]. Exports play an important role in a country's

economic activities. Exports will generate foreign exchange which will be used to

finance the import of raw materials and capital goods needed in the production process

which will form added value. The added value aggregation produced by all production

units in the economy is the value of Gross Domestic Product. An important function of

the export component of foreign trade is that the country gains profits and national

income rises, which in turn increases the amount of output and the rate of economic

growth. With a higher level of output the vicious cycle of poverty can be broken and

economic development can be increased [12].

According to Mankiw [4] the exchange rate between two countries is the price of

the currency used by residents of these countries to trade with one another. From this

definition it can be concluded that the foreign exchange rate is the price of a country's

currency that is valued or expressed in another currency. The weakening of the rupiah

exchange rate makes the price of imported goods increase due to the need for more

rupiah to obtain these imported goods, as well as goods with imported raw materials.

This will also increase the price of domestic production which can lead to economic

growth. Depreciation of the rupiah against foreign currencies also resulted in an

increase in the value of exports. Cheaper domestic goods prices attract foreign parties

to increase the amount of demand for their goods so that prices will slowly rise and

cause inflation [13].

3 Methodology

Data analysis method used in this study is quantitative or time series data, that is, data

within a certain period of time, is used to simplify calculations using statistical data. To

see the effect of inflation, exports and exchange rates the regression model used in this

study is the model dynamic with the Vector Error correction model (VECM) approach.

There are a number of steps that must be taken before estimating VECM: (1). Stationarity

test, (2). Optimal lag test, (3). Cointegration test, (4). Estimation VECM. This study uses

time series data from 1988-2018. The basic equation in this study is as follows:

= ßo + ß1Inf

+ ß2logExp + ß3log Er + µ

(1)

Furthermore, if the equation is formulated in the form of a Vector Error Correction

Model (VECM) then the equation is as follows:

∆Eg

= ßo + β

∆Inf

+ β

∆logExp

+ β

∆logEr

+ β4VECM

1-t

+ µ

(2)

Where it:

Eg = Economic growth

Inf = Inflation

Exp = Export

Er = Exchange rate

ßo = constanta

ß1, ß2, ß3 = coefecient regresion

µt = Error Term

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4 Results and Discussion

4.1 Stationarity Test

Stationarity test is intended to determine the nature and tendencies the data analyzed

whether it has a stable pattern (stationary) or not. If found data that does not have the

properties above (non-stationary), then the various indicators that accompany empirical

results do not indicate a trait valid.

Table 1. Stationarity test.

ADF Unit Root Test

Series Prob. Lag Max Lag Obs

D(Eg) 0.0000 0 6 29

D(Inf) 0.0000 1 6 28

D(logExp) 0.0005 0 6 29

D(logEr) 0.0015 0 6 29

Notes: Based on the stationarity test conducted by the ADF unit root test, the inflation,

exchange rate, exports and stationary economic growth variables are obtained at the 1st

difference. In the ADF test results show us the probability each variable less than α =

0,05.

4.2 Optimal Lag Test

Table 2. Optimal Lag.

Lag LogL LR FPE AIC SC HQ

0 -183.1543 NA 21.01274 14.39649 14.59004 14.45222

1 -104.3749 127.2591 0.171219 9.567297 10.53506 9.845979

2 -75.51724 37.73689* 0.070373* 8.578249 10.32023* 9.079876

3 -61.23093 14.28631 0.105717 8.710072 11.22626 9.434644

4 -36.47706 17.13730 0.101299 8.036697 11.32710 8.984215

5 -1.182872 13.57469 0.100492 6.552529* 10.61715 7.722992*

Notes: From the table above it can be seen that the optimal lag occurs in lag 2, where

in lag 2 there are the most signs *. for further analysis lag 2 is used.

4.3 Cointegration Test

Cointegration test is one of the tests in the dynamic model. The purpose of the test is to

find out whether there is a relationship the long run among variables. This test is a

continuation of the test stationary. The main purpose of this cointegration test is to find

out whether stationary cointegrated residuals or not. If the variable is cointegrated then

there is a stable relashionship in the long run. Conversely, if there is no cointegration

between variables, the implications no long term relationship. After knowing that the

Long-term Analysis of Inﬂation, Exports and Exchange Rate of Economic Growth in Indonesia

429

data is not stationary, then the next step is to do identify whether the data is

cointegrated. For this reason, cointegration testing is needed. cointegration is used as

an initial indication that the model is used have a long-term relationship (cointegration

relation). Cointegration test results obtained by forming residuals that are obtained by

way of regenerating independent variables to the dependent variable OLS.

Cointegration Test can be done with DF testing to test the residuals generated, if the

residuals are not stationary (prob> 0.05), then it can be said that the data it is not

cointegrated [14] [15].

Cointegration test is used to see whether there is a long run relationship among the

variables. To see the cointegration test used in this research is the Johansen test, if the

statistical trace value is greater than the critical value it’s means there is cointegration

each variabels in the research. So the model chosen is the Vector Error Correction

Model (VECM). Based on the results of the cointegration test variable data shown in

table 3, there is 1 cointegration equation at a significant level of 5%. Therefore, the

variables of economic growth, inflation, exports and the exchange rate have the liniear

combination which is stationary (cointegration). cointegration shows that there is a

long-term relationship between variables so that the variables form a linear relationship.

cointegration in the equation system implements that in the system there is a Vector

Error Corection Mechanism which illustrates the existence of a short-term dynamic

relationship that is consistent with its long-term relationship.

Table 3. Uji Kointegrasi-Johansen Cointegration Test.

Unrestricted Cointegration Rank Test (Trace)

Hypothesized Trace 0.05

No. of CE(s) Eigenvalue Statistic Critical Value Prob.**

None * 0.716362 70.07701 63.87610 0.0137

At most 1 0.543324 34.79544 42.91525 0.2536

At most 2 0.293594 12.84958 25.87211 0.7498

At most 3 0.105373 3.117756 12.51798 0.8622

Trace test indicates 1 cointegrating eqn(s) at the 0.05 level

* denotes rejection of the hypothesis at the 0.05 level

**MacKinnon-Haug-Michelis (1999) p-values

Unrestricted Cointegration Rank Test (Maximum Eigenvalue)

Hypothesized Max-Eigen 0.05

No. of CE(s) Eigenvalue Statistic Critical Value Prob.**

None * 0.716362 35.28157 32.11832 0.0198

At most 1 0.543324 21.94586 25.82321 0.1499

At most 2 0.293594 9.731821 19.38704 0.6475

At most 3 0.105373 3.117756 12.51798 0.8622

Max-eigenvalue test indicates 1 cointegrating eqn(s) at the 0.05 level

* denotes rejection of the hypothesis at the 0.05 level

**MacKinnon-Haug-Michelis (1999) p-values

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430

Notes: based on the cointegration test variables inflation, exports and the exchange rate

have a long-term effect on economic growth. This can be seen from the trace value of

statistics> critical value and can also be seen from the value of max eigen> critical

value.

4.4 Estimation VECM

The concept of cointegration states that if one or more variables are not stationary

cointegrated then the linear combination between the variables in the system will be

stationary so we get a term equation system stable length. Here are the results of the

long-term model estimation:

Table 4. Vector Error Corection Model.

Cointegrating Eq: CointEq1

Eg(-1) 1.000000

Inf(-1) -0.656773

(0.17599)

[-3.73178]

logExp(-1) -6.361451

(1.73971)

[-3.65662]

Log Er(-1) 5.809337

[ 3.76947]

C 22.19523

Error Correction: D(Eg) D(Inf) D(logExp) D(logEr)

CointEq1 -0.733053 2.499481 0.000190 0.011717

(0.16862) (0.57775) (0.00844) (0.01386)

[-4.34725] [ 4.32626] [ 0.02249] [ 0.84529]

Notes: VECM model is used in this study to see the long-term relationship of

cointegrated equations. From the estimation results of the VECM equation the long-

term relationship between economic growth, inflation, exports and the exchange rate is

obtained. VECM estimation results can be seen in table 4 which explains that the

variables of economic growth have a long-term relationship with variables of inflation,

exports and the exchange rate. Based on the long-term analysis of the VECM model it

is found that inflation and exports negatively affect economic growth. While the

exchange rate variable has a positive influence on economic growth. the results of the

analysis of an increase in inflation of 1% will have an impact on the decline in economic

growth of 3.73178%.export variable has a negative influence which explains that an

increase in exports of 1% will reduce economic growth 3,65662%. This is due to

Indonesia exporting more agricultural products which have lower exchange rate than

industrial goodsthis is due to Indonesia exporting more agricultural products which

have lower exchange rate than industrial goods. Exchange rate variables have a positive

influence on economic growth, this means that if the exchange rate increases 1% then

Long-term Analysis of Inﬂation, Exports and Exchange Rate of Economic Growth in Indonesia

431

economic growth will increase 3.76947%. In the short-term estimation only inflation

affects economic growth while exports and the exchange rate have no short-term effect

on economic growth. The most important thing from the short term equation is the value

of error correction. Error Correction coeficient of -0.733053. This shows that the

imbalance in economic growth in the current year 2018 will be corrected in the

following year by 73.3053%

5 Conclusion

Based on the research that has been done, it can be concluded all stationary variables

in the first diference and cointegrated in lag 2. There is a long-term effect between

inflation, exports and the exchange rate on economic growth. Inflation and exports has

negative affect on economic growth.While the exchange rate variable has a positive

affect on economic growth. While the exchange rate variable has a positive influence

on economic growth. the results of the analysis of an increase in inflation of 1% will

have an impact on the decline in economic growth of 3.73178%.export variable has a

negative influence which explains that an increase in exports of 1% will reduce

economic growth 3,65662%. In the short-term estimation only inflation affects

economic growth while exports and the exchange rate have no short-term effect on

economic growth While in the short term only exchange rate variables affect economic

growth. The most important thing from the short term equation is the value of error

correction. Error Correction coeficient of -0.733053. This shows that the imbalance in

economic growth in the current year 2018 will be corrected in the following year by

73.3053%.

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