Spillovers of United States and People’s Republic of China Shocks on Small Open Economies

Abstract

This chapter examines the impact of certain external shocks originating from the United States (US) and People’s Republic of China (PRC) on Indonesia as a small open economy. The spillover effects of tapering off, an interest rate hike, exchange rate devaluation, and real gross domestic product (GDP) are analysed. Two versions of the global vector autoregression model are employed, which covers 33 countries and considers both financial and trade relations among countries. The results suggest that the main risk for Indonesia’s real GDP is a shock to the PRC’s real GDP, while a US interest rate hike is the greatest risk to Indonesia’s exchange rate depreciation in the short term, especially compared to the US tapering off. Moreover, the dominant transmission channel of US monetary tightening is through finance, dampening economic growth in small open economies.