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Economics Balance of Payment

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Indonesia’s central bank made an unexpected move to contain the country’s current account deficit, a negative value in the measure of the flow of funds from trade in goods and services. The Central Bank raised the interest rate by 0.25% to 7.5%. Moreover, recently in August Indonesia faced a hike in the inflation rate, thus raising the interest rate would also help to control the inflation. Inflation is a sustained increase in price levels of an economy. As mentioned in the article, the Central Bank predicted that they could ease the current account deficit to $8.4 billion in the third quarter, from $10 billion in the second quarter by raising the interest rate. Raising the interest rate is a deflationary monetary policy that is aimed to reduce the Aggregate Demand in the economy. This can be depicted through figure 1.0. The Central Bank raised the interest rate to correct the current account deficit. With higher interest rates, consumers are encouraged to save money instead of spending money, thus the Aggregate Demand would decrease. This also means that the consumption of imports would significantly drop to some extent, which helps to correct the current account deficit.
The decision made by the Central Bank to run an expenditure-reducing policy by raising the interest rate of Indonesia has its advantageous and disadvantages. Recently in June the government cut its subsidies on fuel, which caused a hike in inflation rate. Raising interest rate would lead to a lower inflation rate would lead to greater competitiveness of export products because the average price level would be relatively less expensive. With more exports revenue, this would help to correct the current account deficit. The advantage of this is that domestic exporting firms are able to grow in their economies of scale in this period when exports are more attractive. For example, export firms

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