How Monetary and Fiscal Policies Shape Economic Growth: Evidence in Indonesia

Abstract

Economic growth in emerging markets is often shaped by the interplay between fiscal and monetary policies, yet the relative contributions of each remain debated. This study addresses the problem of identifying which policy instruments most significantly explain fluctuations in Indonesia’s GDP growth. The objective is to evaluate the dynamic effects of fiscal and monetary shocks and to quantify their structural importance over different horizons.
Using a Vector Autoregression (VAR) framework, the research employs impulse response functions (IRF) and variance decomposition (VD) to capture both short run dynamics and long run contributions. The dataset includes key fiscal variables—government expenditure and household consumption—and monetary indicators such as policy interest rate (BI7DRR), exchange rate, and inflation.
The findings reveal that in the short run, GDP growth is largely self driven, while monetary shocks exert limited influence. Over longer horizons, government expenditure emerges as the dominant driver, explaining nearly 40% of GDP variance, whereas monetary variables remain marginal contributors. Household consumption plays a stabilizing role but does not structurally dominate GDP variance. These results highlight the asymmetry between fiscal and monetary policy: fiscal expansion provides sustained growth momentum, while monetary stability ensures that such expansion remains viable. The study contributes to the literature by offering empirical evidence that coordinated fiscal and monetary strategies are essential for sustainable economic development.