IB Economics HL 3.5.1 Monetary policy Question Bank

Study the extract below and answer the questions that follow.
Indonesia's current account deficit

(1) Bank Indonesia, the central bank of Indonesia, kept its main interest rate steady, because a large current account deficit limited its ability to lower borrowing costs to support a slowing economy. The current account deficit is expected to reach US $\$ 27$ billion by the end of the year. The deficit widened due to seasonal factors, such as foreign debt payments and the transfers of funds overseas by multinational corporations (MNCs) repatriating earnings.

(2) Indonesia's current account has been in deficit for 11 consecutive quarters as the slump in commodity prices in recent years has reduced export revenues, while import expenditure has remained high as a consequence of the country's strong economic expansion.

(3) In mid-2013, the current account deficit was even bigger, inflation neared 10 %, and the exchange rate of the rupiah (Indonesia's currency) rapidly decreased by 21 %. In response, Bank Indonesia tightened monetary policy. This slowed down inflation, but also slowed economic growth. The value of the Indonesian rupiah has increased by more than 4 % this year, although it is still undervalued.

(4) This year, the economy has been growing at 5.1 %, the slowest pace since 2009. A weaker rupiah is hurting some businesses, and so a continued appreciation in the currency could help strengthen the economy by reducing import prices.
5 The governor of the central bank said that the current interest rate level, in place since November 2013, was consistent with its 3.5 % to 5.5 % inflation target. He also predicted that the current account deficit for the second half of 2014 would be smaller due to the increase in exports of mineral ores.

(6) Economists have suggested that the best way to lower the deficit would be to cut oil imports by raising domestic oil prices. It has been suggested that the central bank has done its job by tightening monetary policy and now it is the government's job to raise fuel prices, by reducing fuel subsidies. This would help to reduce both the current account deficit and the budget deficit.

(7) There are also future threats as the United States is expected to raise its interest rates in the coming year. This could intensify capital flows from fast growing developing economies to developed economies, and further fuel price increases are likely in world markets. "Indonesia's Current Account Deficit Widens in Q2 to 4.27 \% of GDP", Jakarta Globe, 14 August 2014 and "RI back in 'fragile' condition", The Jakarta Post, 15 August 2014]
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Define the term monetary policy indicated in bold in the text (paragraph (3).