1.

Introduction

Since the onset of the global financial crisis, many central banks have introduced
unconventional monetary policy (UMP) tools, including quantitative easing (QE)
and maturity extension programs (MEP).1 According to Bernanke (2020), U.S QE
hasve stabiliszed the economic condition since it successfully reduced longer term
interest rates. Nevertheless, one should notice that the effects of three QE programs
(QE 1, QE 2 and QE 3), which were implemented from 2008 to 2013, depended
heavily on whether the zero lowerzero-lower bound (ZLB) wais binding (Gertler and
Karadi, 2013). 2

For the last decade, the debateiscussion onf how U.S. UMP affects the emerging
market economies has remained inconclusiveopen, as has the econometrics approach
used to study this particular issue. Anaya et al. (2017) discovered by using Global
Vector Autoregressive (GVAR) found that U.S. UMP increased emerging market
economies’ output growth by using Global Vector Autoregressive (GVAR), whereas
Bowman et al. (2014) showedn by employing VAR and event study analysis that U.S.
UMP affects developing countries’ sovereign yield, by employing VAR and event
study analysis. In addition, Tillmann (2016) employed Qual VAR and found that the
U.S. UMP mainly affects emerging market economies’ capital inflows.

Therefore, there have been voluminous studies to assess the global spillovers of U.S.
UMP using VAR approach in developing countries, including Indonesia. 3 However,
there areis limited studies on regarding this issue in Indonesia using Factor
Augmented VAR (FAVAR) approach, due to the complexity of the method and the
data constraints. Therefore, this paper aims to enrich the literature regarding the
global spillovers of U.S. UMP in Indonesia by employing FAVAR approach, the
empirical strategies developed by Bernanke et al. (2005). The study aims to answer
research questions regarding: (1) Does the U.S. UMP affect Indonesia’s financial
variables during the ZLB period?, (2) How long does the U.S. UMP affect

1
QE 1, 2 and 3 were announced in November 2008, November 2010 and September 2012 respectively as part of
U.S. UMP to inject liquidity into the financial system. In addition, the Fed employed MEP 1 and 2 in September
2011 and June 2012 as part of large-scale asset purchases program (Ihrig et al., 2018).
2
ZLB is a macroeconomic problem that occurs when the short-term nominal interest rate is at or near zero,
causing a liquidity trap and limiting the central bank’s capacity to stimulate economic growth.
3
See, amongst others, Chen et al. (2014) and Bhattarai et al. (2015)
 Indonesia’s financial variables during the ZLB period? and (3) Does the impact
differ with among QE 1, QE 2, MEP, and QE 3 programs during the ZLB period?

Employing the FAVAR approach benefits this study in two ways. First, it is possible
we are able to include a large number of data series to make completefull use of
information without being constrained by concerns about preserving the degrees of
freedom, as is the case with a standard VAR approach. The second advantage is that
the FAVAR method enables allows us the o study of the impact of U.S. UMP on the
Indonesian economy. 4 U.S. UMP may have either direct or indirect impact on the
Indonesian economy, and we can plot the impulse responses of these Indonesian
economy due to unpredicted innovation in U.S. UMP can be plotted, after
controlling for a rich information set. Dahlhaus et al. (2018) and Ho et al. (2018)
utilissed the FAVAR method to estimate the impact of U.S. UMP on a the particular
country. The first paper measures the global spillovers of QE on the Canadian
economy, whereas the latter estimates the effect of U.S. QE on the Chinese one
economy.

Indonesia has been chosen as an essential case to highlight global spillovers of U.S.
UMP for athe number of reasons. First, Indonesia constitutes is part of the “Fragile
Five” countries due to its its vulnerability of its condition to the U.S. UMP (Bhattarai
et al., 2015). Second, Indonesia boasts of has a strong trade and financial
relationship with the U.S., which making es it reasonable to expect international
transmission of the U.S. monetary policies. Specifically, Indonesia is highly
dependent on the U.S. for its international trade since itU.S. is its the Indonesia’s
largebiggest export partner.

Regarding the identification method, papers in the literature differ on along various
aspects. Many papers mostly use a high-frequency data to measure the effect of the
U.S. monetary policies more accurately. For example, Gurkaynak, Sack and
Swanson (2005, henceforth GSS) employed a high-frequency data to measure the
effects of U.S. conventional monetary policy on bond yield. Similarly, Gertler and
Karadi (2015) used a high-frequency shock around policy announcements to
estimate the effectiveness of U.S. conventional monetary policy. They found that the

4
We will use tThe term Indonesian economy and Indonesia’s financial variables will be used interchangeably.
 use of an intraday data is more accurate due to its ability to isolate the impact of
policies within a tight window. In measuring the conventional monetary policy
shock, one can use federal funds futures (GSS, 2005). However, estimating the
impacts of UMP on financial variables is more difficult since there is inno sufficient
data to measure the UMP surprise. A number of approaches have been used to
examine the effects of U.S. UMP shocks. Swanson (2017) adopted the GSS method
and estimated the effect of forward guidance and QE separately to measure the
UMP shock.

A We take different approach is taken in this paper, which is however limited to

measuring the relative effects of U.S. UMP on Indonesia’s financial variables.
Adopting Rogers et al. (2014), we define the U.S. UMP surprise is defined as the
daily changes in government bond yields right around the announcement, and then
regress Indonesia’s financial variables around the announcement on this measure of
the monetary policy shock are regressed. 5 In other words, this paper studiesy the
response of how Indonesia’s financial variables respond to U.S. UMP shock,
assuming that the shock around the announcements is the only driver of
Indonesia’s financial variables. Therefore, although the literature to measure the
effect of U.S. UMP on emerging economies is large and growing fast, this our paper
presents has a novel aspect because of its y emphasis on zing the daily data.

Furthermore, there are two crucial aspects regarding this methodology. First, it
only investigates only the pass-through from a given change in government bond
yields onto Indonesia’s financial variables, not the impact of U.S. monetary policy
in affecting treasury bond yields. Second, it estimates the total effect of monetary
policy on Indonesia’s financial variables, without decomposing it into the effect of
specific policies. 6

We tThen use the large number of the Fed’s UMP announcements is used to support
our daily analysis. Hence, this paper relies on the two main assumptions. First, it is
we assumed that the U.S. UMP shocks affect U.S. daily bond yield one day after the
5
This argument is also supported by Bernanke (2020), Ihrig et al. (2018), Gagnon et al. (2011) and
Krishnamurthy and Vissing-Jorgensen (2011) who argue that the U.S. UMP has an immediate and strong effect
on U.S. treasury yield.
6
U.S. monetary policy announcements covered policies of various types. Therefore, it is harder to decompose
the announcements into specific type of U.S. UMP (Rogers et al., 2014).
 announcements and the changes in U.S. daily bond yield affect Indonesia’s financial
variables the one day after the changes in the yield due to the time difference between
U.S and Indonesia. Second, it is we assumed that the changes in U.S. daily bond
yield within a tight window isolate the impact of news about U.S. monetary policy.

2. Literature Review

2.1. Unconventional Monetary Policies

To overcome the global financial crisis in 2008-–2009, the U.S. hasve deployed
UMP due to the ZLB constraint, including QE. 7 By injecting liquidity into the
financial system, the U.S. UMP raises increase bank’s lending capacity, thus that
can improvinge real economic activity eventually (Wang, 2019).

2.1.1. Quantitative Easing (QE)

The Federal Reserve has employed QE due to the federal funds rate already
being close to the ZLB. Many assume that QE is money creation. However,
Gertler and Karadi (2013) argue that QE should be considered as a central
bank intermediation that which can stimulate economy in the ZLB condition. By
using QE, the central bank can has the ability to influence affect long-term
interest rates and achieve price stability when short-terms policy rate is at or
almost zero. 8

QE 1, QE 2, and QE 3 have been implemented during the period from 2008 to

2014 (Maggio and Kermani, 2020). Krishnamurthy and Vissing-Jorgensen
(2011) found that QE affects U.S. interest rates on Treasuries. Similarly,
Bernanke (2020) observed found that QE significantly affects United States’s 10-
year treasuries. Moreover, the empirical result from Bauer and Neely (2014)
demonstrated showed that QE affects international bond yield through two main
channels. More importantly, the QE announcement by the Fed also has

7
The term zero-lower bound embraces the possibility of negative short-term rates. In the United States, thus far
the effective lower bound has been zero. I will use the term zero-lower bound (ZLB) for short.
8
See, amongst others, Belongia and Ireland (2018) and Sims and Wu (2020).
considerable effects since the announcement of starting (exiting) QE has
expansionary (contractionary) effects on to the economy (Meinusch and
Tillmann, 2017). Therefore, the timing of QE announcements is crucial in order
to measure the international spillovers of U.S. UMP.

2.1.2. Forward Guidance

The central banks in several countries (e.g., the Federal Reserve and Bank of
England) have considered a forward guidance, or “open mouth operations”
(Guthrie and Wright 2000), as an alternative monetary policy tool since it
influences market beliefs about the expected fed funds rate. Such a measure is
mostly implemented in the context of a ZLB period and associated with as
expansionary monetary policy. Svensson (2015) argues that forward guidance is
a natural part of a monetary policy since it improves central bank’s
transparency in to achieving e its monetary target.

According to Bernanke (2020), the Fed used forward guidance in its speeches.
Specifically, a the form of Federal Open Market Committee (FOMC)
communication such as “keep rates low and policy accommodation can be
maintained for a considerable period” is considered as forward guidance.
Furthermore, the Fed has refined improved the use of forward guidance from
2007 through 2018 to communicate their future expectation to the market in
which the forward guidance plays has a more significant role after the financial
crisis (Eberly et al., 2020).

The effectiveness of forward guidance in to influencinge both short -term and

long-term interest rates has been researched extensively, particularly after the
onset of the global financial crisis. Hubert and Labondance (2018) found that
European Central Bank (ECB) forward guidance had proven effective in to
lowering a short-term interest rates. Nevertheless, Sinha (2015) revealed shown
that forward guidance affects not only affects short term interest rates but also
long-term asset yields. Furthermore, separating the guidance into two forms
(Delphic and Odyssean), Campbell et al. (2012) found that the forward
guidance through FOMC announcements significantly affected U.S. interest
rates, including treasury bond rates, corporate borrowing rates, and private
 9
macroeconomic forecasts. In addition, Bernanke (2020) proved shown that
forward guidance strongly influences U.S. treasuries.
However, forward guidance should be combined with other UMP (e.g. QE) to
become more effective due to its limitation in to boosting economic growth when
there is a large and persistent shock to the natural rate (Levin et al., 2010).
Similarly, Neely (2010) observed found that QE had a larger effect on asset
prices compared to other UMP such as forward guidance. In addition, Mckay
et al. (2016) found that forward guidance also has also a limitation in to
stimulating the e economy in the presence of uninsurable income risk and
borrowing constraints.
2.2. Global Spillovers of U.S. UMP
Using Panel VAR, Bhattarai et al. (2015) demonstrated shown tthat an increase
in U.S. QE affects exchange rate on emerging market economies. More
importantly, the effect of U.S. monetary policy on those financial variables is
more significant for the “Fragile Five” countries (e.g., Indonesia). Moreover,
by using VAR and event study method, Bowman et al. (2014) found that U.S.
UMP strongly affects emerging market economies’ sovereign yield by using
VAR and event study method, even though the results are dependent on the
country-specific characteristics such as macroeconomics stability. Chen et al.
(2014) found that U.S. UMP hasve a larger global implication than do t
conventional policies. They also discovered found that GDP growth, inflation,
market capitaliszation, and local debt held by foreigners of the recipient
countries influence the effect of U.S monetary policy in which countriesy with a
better fundamentals characteristics help dampen the effect. Anaya et al. (2017)
employed a global VAR to investigate the impact of U.S. UMP on emerging
market economies. They found that such policy encourages capital outflows
from the U.S. to emerging markets, resulting in an increase in real output
growth. In addition to QE, Lombardi et al. (2019) measured the forward
guidance effect using text analysis software to estimate the impact of the
statements from the Federal Open Market Committee on small open advanced
economies. Their research showedn that the impact of U.S. UMP has been more
significant since the end of the great recession.
9
Delphic forward guidance informs an estimation of macroeconomic performance explicitly and intended
monetary policy stance based on the policymaker’s measurement. On the other hand, Odyssean forward
guidance does publicly commit the policymaker to control public expectation.
 To measure the impact of U.S. monetary policy, existing literature frequently
utilisses high-frequency data. By using daily data around monetary policy
announcements, one can assume that the changes in macroeconomic or
financial variables are influenced only by the surprise component of monetary
policy innovations. Gurkaynak et al. (2005) proposed the use of high-frequency
data to measure the impact of the unexpected changes in the federal funds rate
on bond yields. They use a federal funds futures to measure a monetary policy
shock. 10 Similarly, Gertler and Karadi (2015) use fed funds futures rate as a
conventional monetary policy surprise.

Some papers also use a low-frequency data to measure the impact of monetary
policy transmission. For example, Tillmann (2016) also combined put a
macroeconomic low-frequency data (e.g., inflation) with Qual VAR to measure
the impact of U.S. monetary policy. He found that QE has a strongly impacted
on emerging markets’ capital inflows.

2.3. Measuring the Impact of U.S. UMP Using a FAVAR Approach

An eExisting literature mainly used VAR to measure the effectiveness of
monetary policy transmission on the economy. Bernanke et al. (2005) proposed
a FAVAR approach as an extended version of traditional VAR. VAR and
SVAR are commonly lead to a misinterpretation of ed results such as “price
11
puzzle”. Therefore, FAVAR provides a more comprehensive analysis in
measuring the impact of monetary policy innovations on the economy.

With the exception of Dahlhaus et al. (2018) and Ho et al. (2018), there is
limited research to assess international spillovers of U.S. monetary policy on a
the particular country using a FAVAR method. By using a two-country FAVAR
approach, the former measured the impact of U.S. QE on the Canadian
economy. Adopting the FAVAR method developed by Bernanke et al. (2005),
10
Federal funds futures have traded based on the average effective short-term policy rates that areis
realizedrealized for the calendar month specified in the contract (GSS, 2005).
11
“Price puzzle” is one of the standard illustrations of the VAR potential problem. This refers to Sims’s (1992)
interpretation of the so-called “pricze puzzle”, the main finding in VAR literature that a contractionary monetary
policy shock is followed by a slight increase in the price level, rather than a decrease as like standard economic
theory would predict.
 they estimate the FAVAR by a in two -steps approach: i) The unobserved
factors are estimated through principal component analysis, ii) Both
unobserved factors and observed policy variables are then estimated into the
VAR model. However, they modified the a FAVAR method by considering a
counterfactual case in which the Fed would not increase its balance sheet to
tackle the global financial crisis. As a result, they observed found that U.S. QE,
which measured as a total long-term asset holdings in the Fed’s balance sheet,
increased Canadian GDP by 2.7% and reduceds long-term spreads mainly
through financial channels, compared to the no-QE scenario. Moreover, Ho et
al. (2018) employed the a FAVAR method to estimate the effect of U.S. UMP on
the Chinese economy. They used the shadow policy rate (constructed by Wu
and Xia, 2016) as a measurement of monetary policy stance when the Fed
deployed UMP. They found that U.S. monetary policy has a strong impact on
Chinese real estate. Ssuch policy has no impact on Chinese trade balance.

3. Methodology, Empirical Strategy, and Data

3.1. Methodology

Assuming that the U.S. UMP announcements have an immediate impact on

U.S. government bond yield, the remainder of the paper seeks to measure three
things to address answer three research questions: a) the pass-through effect of
U.S. daily bond yield rate into Indonesia’s financial variables, b) the persistence
of such effects, c) the difference of such effects during the among QE 1, QE 2,
MEP, and QE 3 periods.

This study will employ use the FAVAR method developed by Bernanke et al.
(2005), which enhances earlier research using the VAR approach, to investigate
the impact of U.S. UMP on the Indonesian economy. 12 According to Bernanke
et al. (2005), policy makers considers unobserved information as an the abstract
concept such as “economic activity”, “price factor”, and “credit condition” in

12
Therefore, methodology oin this paper mainly adopts Bernanke et al. (2004) and Rogers et al. (2014) to
identify U.S. UMP surprise and the FAVAR approach, respectively.
their decision-making process. Therefore, in this research, let Ft be a K x 1
vector of unobserved factors. In addition, let Xt (N x 1) vector consist of a large
number of observed financial variables (the daily changes in Indonesia’s
interest rate, stock price, and exchange rate) that explain the abstract economic
situation, which cannot be easily explained (F t). Moreover, we have observed the
variables represented by Yt (the daily changes in U.S. daily government bond
yield in 2 year2-year, 3 year3-year, 5 year5-year, 7 -year and 10 year10-year
maturities) have been observed as a M x 1 vector in which the we aim is to
measure how the changes of Yt affects Ft.

Therefore, specifically, we use a two- steps approach has been deployed in

estimating the FAVAR. First, the unobserved factors F t and observed factor Yt
are estimated through principal component analysis. For unobserved factors F t,
principal component analysis is obtained from datasets X t, whereas principal
component analysis for observed factor Y t is obtained from U.S. daily bond
yield dataset. All principal components are then normaliszed to have unit
variance. Second, both unobserved factors and observed variables are then cast
into a restricted VAR model. Furthermore, the impulse response function and
forecast error variance decomposition will be used in this research to determine
the global spillovers of U.S. daily bond yield on the Indonesia’s financial
variables.

The method described above is intended to measure not only the immediate
effect of U.S. daily bond yield on the Indonesia’s financial variables, but also the
persistence of such effect. The persistencet of U.S. daily bond yield effect on
Indonesia’s financial variables is are described by the movement of impulse
response functions. In measuring the persistence, we use four measurement
periods have been used: QE 1, QE 2, MEP, and QE 3, by using impulse response
functions.

According to the event study literature, the effects are long lasting (Fama et al.,
1969). However, some crucial U.S. UMP shocks were occuredoccurred at a time
when financial markets were impaired, and so the impact effects of QE on bond
yields may be significant. In addition, in a QE period, many firms tend to issue
 corporate long-term bond (Stein, 2012), pushing long -term rates higher. As
arbitrage capital returned to financial markets, the effects would have got
smaller.

3.2. Empirical Framework

3.2.1. Structural Factors

As explained in the methodology, in this research, the vector of unobserved
variables Xt and observed variables Yt will be grouped so that each variable is
explained by one of the following structural factors:
1) Exchange Rate Factor: It indicates an Indonesian exchange rate compared
to another country’s exchange rate.
2) Stock Price Factor: This factor expresses the movement of stock prices in
Indonesia’s stock exchange.
3) Interest Rates Factor: This factor defines government bond yield in several
maturities and in interest rate in banking.
4) U.S. UMP Factor: This factor is reflected by the U.S. daily treasury yield
rate in several maturities.

3.2.2. The Dataset

The daily dataset spans from November 2008 to December 2013 as the Federal
Reserve has announced 40 UMP announcements UMP during that time. The
data are aggregatedcollected from various sources including Federal Reserve
Economic Data, CEIC, Bank Indonesia website, and others (Appendix 2). 13 All
series have been transformed to reach stationarity and have been seasonally
adjusted, if necessary.14 They have also been demeaned and standardiszed.

3.2.3. The FAVAR Estimation

13
CEIC is officially used by Central Bank of Indonesia. Hence, we can expect that the data is expected to be
credible.
14
This research applies the Augmented-Dicky Fuller to test the stationary of all variables.
In order to avoid the estimation bias from the U.S. UMP, the main analysis of
this research focuses on the ZLB period, from November 2008 to December
2013. This is mainly because the effect of U.S. UMP will be more significant in
during such period (Bernanke et al., 2020). This research then relies on the two
main following assumptions.

First, it is we assumed that U.S. UMP surprise affects U.S. daily bond yield one
day after the announcements and U.S. daily bond yield affect Indonesia’s
financial variables one day after the changes in U.S. daily bond yield. U.S. UMP
announcement on 25 November 2008 was expected to significantly change U.S.
daily bond yield in several maturities on 26 November 2008. Then, the changes
in U.S. daily bond yield on 26 November 2008 were expected to significantly
change Indonesia’ financial variables on 27 November 2008

Second, it is we also assume that the changes in U.S. government bond yield
within a tight window isolate the impact of news about U.S. monetary policy.
This assumption is also crucial since one may consider that daily data is not
strong enough compared to intra-daily data. However, there is an we
assumptione that this method (using daily data) is plausible and strong enough
since it is tight enough to isolate the impact of U.S. UMP shock on U.S. daily
bond yield and Indonesia’s financial variables, especially if we compare the
daily data is compared with monthly data. In addition, there is we have a
constraint in collecting the intra-daily data in the U.S. and Indonesia’s financial
variables.

3.2.3.1 The Pass-Through Beyond U.S. Government Bond Yield

This research aims to discover the relationship between U.S. daily government
bond yield and Indonesia’s financial variables by analyzinganalysing the sign of
the model estimation result using the FAVAR method. As mentioned in the
previous section, we first make a factor of all variables through the principal
component analysis is first made. After making the principal component
analysis, we then estimate the result is estimated.
 One should consider that we take it as given that the Fed is capable of producing
immediate effects on their own government bond yield. Therefore, we directly
estimate the impact of the U.S. daily treasury yield rates factor on Indonesia’s
financial variables is directly estimated. We expect to measure wWhether the
changes in such yield will increase or decrease Indonesia’s financial variables is
expected to be measured.

3.2.3.2. The Persistence of the U.S Daily Government Bond Yield Effect
This paper also measures the persistence of U.S. daily bond yield in affecting
Indonesia’s financial variables to measure the impact more accurately. The
persistence of the U.S. daily bond yield effect is depicted in the impulse response
functions. By using the FAVAR method, we investigate the persistence
throughout 30 days will be investigated. For example, for the changes in U.S.
daily bond yield on 26 November 2008, we measure its effect on Indonesia’s
financial variables from 27 November 2008 to 30 days ahead will be measured.
Therefore, it will be we are possible able to measure how long the U.S. daily
bond yield affects Indonesia’s financial variables. In addition, we will compare
the persistence of the effect on each announcement (there are 40
announcements) during QE 1, QE 2, MEP, and QE 3 period on Indonesian
economy will be compared to determine the difference in among those U.S. asset
purchase programs.

4. Results
Considering the existing literature review and Indonesia’s macroeconomic
condition, this research estimates the impact of U.S. UMP to Indonesian economy.
We choose tThosee representative variables of the Indonesian economy have been
chosen, which that are collectible in daily period to investigate their dynamics in
response to U.S. UMP shock, reflected by U.S. daily bond yield.
 It was We assumed that the U.S. UMP surprise is represented by the U.S. daily bond
yield in order to capture the high-frequency data during the U.S. UMP
announcement. In addition, it was we assumed that there is a one-day lag between
the U.S. monetary policy announcement and the changes in U.S. daily bond yield
and one-day lag between U.S. daily bond yield and Indonesia’s financial variables
due to the time difference between U.S. and Indonesia.

The We will first measure the pass-through effect of U.S. daily bond yield on
Indonesia’s financial variables will be measured first. We will then measure Tthen the
persistence of U.S. UMP effects will be measured and compare the effect in among
QE 1, QE 2, MEP, and QE 3 announcements periods will be compared. Specifically,
U.S. UMP announcements correspondings to the QE 1 were occurred from 25
November 2008 to 23 June 2010 (12 announcements in total)., U.S. UMP
announcements correspondings to the QE 2 were occurred from 3 November 2010
to 9 August 2011 (8 announcements in total)., U.S. UMP announcements
correspondings to the MEP were occurred from 21 September 2011 to 22 August
2012 (9 announcements in total), and finally U.S. UMP announcements
correspondings to the QE 3 were occurred from 13 September 2012 to 18 December
2013 (11 announcements in total). During those 40 announcements, some
announcements also reflect a forward guidance measure as a crucial part of the
U.S. UMP. We first show Wwhat would happen to Indonesia’s financial variables if
the economy were hit by an expansionary U.S. UMP shock is shown first. Then, for
each period, it is we will shown how long such shock can influence the Indonesia’s
financial variables. Finally, we will compare the result of each announcements
period will be compared to determine the largest and smallest magnitude as well as
the persistence of the effect.

4.1. The Pass-Through Beyond U.S. Government Bond Yield

First of all, this paper tries to examine the impact of the changes in U.S. daily
government bond yield on the Indonesia’s financial variables. We adopt The
FAVAR method explained by Bernanke et al. will be adopted (2005) and also
adopt Rogers et al. (2014) to measure the U.S. UMP surprise by using U.S. daily
bond yield. As Indonesia is a small open economy, this research assumes that
 U.S. government bond yield could affect Indonesia’s economy, but not vice
versa. 15

All the factors used in this FAVAR model are stationary. Table 3 presents the
impact of U.S. daily bond yield factor on the Indonesia’s interest rate factor,
stock price factor, and exchange rate factor. Changes in the U.S daily bond
yield factor appear to affect Indonesia’s stock price factor and exchange rate
factor. This is mainly because QE encourages capital outflow from U.S. to
emerging economies, including Indonesia, which is also known as “hot money”.
The hot money moves to the Indonesia stock exchange, resulting in an increase
in Indonesia’s stock price. In addition, hot money from U.S. to developing
economies also leads to an appreciation in the emerging economies’ currency,
including Indonesia rupiah. In other words, an increase in QE raises
Indonesia’s stock price and appreciates Indonesia’s currency compared to
other country’s currency.

In contrast, Indonesia’s interest rate factor is not significantly affected by the

changes in U.S. daily bond yield factor. It is plausible since interest rate is
influencedaffected by more complex factors, mainly driven by domestic inflation
according to the standard economic theory. The higher the inflation, the higher
the interest rate applied by the central bank to reduce inflation. Moreover, in
some countries, particularly in emerging economies, interest rate could also be
affected by the GDP growth. For example, the lower the GDP, the higher
probability of to reduction in e interest rate by the central bank in order to
boost economicy growth through bank lending.

4.2. The Persistence of the U.S Daily Government Bond Yield Effect
This paper measures the persistence of the U.S. daily bond yield effect on
Indonesia’s financial variables through impulse response functions, which are
provided by the FAVAR method. In addition, there we will be a comparison of e
the magnitude of the effect on among QE 1, QE 2, MEP, and QE 3
announcements periods to determine the consistency of the effect.

15
In normal conditions, as a small open economy, Indonesia is assumed to have only a small impact on the
global economy.
 Note that we display responses of only 12 impulse response functions results (4
results for Indonesia’s interest rate, stock price, and exchange rate,
respectively) will be displayed from a total of 40 announcements that, in
principle, can represent the final result.16 Figures 1-–12 present the impulse
response functions of all factors. Since this paper uses a high-frequency
identification method (daily data), the unit of the horizontal axis is time
measured in days. The impulse response functions demonstrate the dynamics of
the economy after one standard deviation shock to each factor. 17

4.2.1. Impulse Response of Indonesia Interest Rate Factor to the a U.S. UMP
Factor
According to the results from the previous section, Indonesia’s interest rate is
not affected by the changes in U.S. daily bond yield around the announcements.
Such result is similar to with the impulse response functions results in figure 1 –
4 in which the effect of U.S. daily bond yield on interest rate is inconsistent. In
the QE 1 and QE 3 periods, the changes in U.S. daily yield reduce the
Indonesia’s interest rate, whereas the changes in such yield increases the
interest in other periods. Therefore, there is no possibility we are not able tof
assessing the persistence and magnitude of the effect in interest rate factor.

4.2.2. Impulse Response of Indonesia Stock Price Factor to the a U.S. UMP
Factor
In contrast to with interest rate, Indonesia’s stock prices strongly increase rise
due to the changes in the U.S. daily yield. According to the figure 5 -– 8, the
effect of U.S. monetary policy lasts for around one or two days after the U.S.
UMP announcement. Such a pattern exists for all period (QE 1, QE 2, MEP,
and QE 3). However, the magnitude varies during among a research period in
which the changes in U.S. daily bond yield during QE 1 period haves a larger
magnitude compared to other QE and MEP periods. After 10 days, the U.S.
monetary policy effect completely disappears and Indonesian stock price
becomes flatter.
16
There are is another 12 additional impulse response results in the appendix. Hence, in total, this paper displays
24 results.
17
The scale has been normaliszed to one standard deviation for each to expedite comparison.
 4.2.3. Impulse Response of the Indonesian Exchange Rate Factor to the a U.S.
UMP Factor

The Indonesia exchange rate factor appreciates relatives to other countries’

exchange rates with as the changes in the U.S. daily yield rate. It is
understandable since the decrease in U.S. interest rate leads foreign investors to
buy domestic bonds from Indonesia. This leads the foreign money supply to
increase in Indonesia, ceteris paribus, which in turn drives the exchange rate to
appreciate. According to the graph, QE 3 has a larger magnitude effect since
the Indonesian rupiah appreciated more than one 1 point during that time.
Lastly, the U.S. UMP effect fades 7-–10 days after the announcement.

4.3. Variance Decomposition

In addition to impulse response functions, another model commonly performed
in the standard VAR context is variance decomposition (Bernanke et al., 2005).
The variance decomposition represents the fraction of the forecasting error of a
variable, at a given horizon, which that is attributable to a particular shock.
Following the same logic of obtaining the impulse response of each Indonesian’s
financial variable, we first get the variance decomposition of factors in the VAR
system are first taken and then use the observation equation (3.2) is used to back
out the variance decomposition of each Indonesian’s financial variable.
A standard result of the VAR literature is that the monetary policy shock
explains a relatively small fraction of the forecast error of real activity measures
of inflation. However, in this research, we measure the variance decomposition on
Indonesia’s stock price and exchange rate will be measured since U.S. UMP has
no significant effect on Indonesia’s interest rate. The result reports the
contribution of the U.S. UMP shock to the variance of the forecast error at the
10-days horizon. The variance decomposition of stock price and exchange rate
caused by the changes in the U.S. daily yield is described in tables 1, 2 and 3. The
higher the number demonstrated, the higher the relative importance of that
factor.
 Stock price factor is mostly affected by the interest rate factor rather than the
exchange rate factor. In addition, the interest rate factor strongly affects
exchange rate in Indonesia. Those results are reasonable since they are consistent
with the standard economic theory. For example, the higher the interest rate in
the particular country, the higher the probability of the exchange rate to
appreciatinge relative to another country’s exchange rate since such a country
becomes an attractive place to obtain a high return of investment. In addition,
the lower the interest rate, the higher the probability of investors to investing in
stock market due to the higher rate of return, resulting in an increase in stock
price.

5. Conclusion
In the aftermath of the global financial crisis, major central banks have driven
short rates to what is effectively the ZLB. In this paper, we have studied the effects
of U.S. UMP on Indonesia’s interest rate, exchange rate, and stock prices, have been
studied using common methodologies with daily financial variables. Adopting
Rogers et al. (2014), the U.S. UMP shock is measured by U.S. daily government
bond yield in several maturities. The pass-through of the resulting changes in U.S.
government bond yields to Indonesia’s financial variables is of course essential to
the policy accomplishing its goal. The pass-through is also crucial for to be
measurementd since there is a mixed evidence regarding this issue. Krishnamurthy
and Vissing-Jorgensen (2013) argue that QE had small spill-overs effects on other
asset prices. In contrast, Rogers argues for a that there is considerable pass-through,
and we think that Krishnamurthy and Vissing-Jorgensen underestimate its
magnitude. In addition, we have also attempted to estimate the persistence and
magnitude of U.S. daily bond yield effect on Indonesia’s financial variables for 40
U.S. UMP announcements. This is difficult to identify with much precision, but our
point estimates indicate that the effects wear off, although slowly.

By employing the FAVAR approach and the high-frequency identification method,

this study finds that the U.S. daily bond yield hasve an immediate and significant
impact on Indonesia’s stock price and exchange rate right after the U.S. UMP
announcements. Indonesia’s stock price rises dramatically as the foreign investors
prefer to invest in emerging markets while the expected return in advanced
economies becomes smaller. Furthermore, shifting in capital flow from advanced to
emerging economies appreciates developing countries exchange rate, including
Indonesia. All of results are similar to with the existing literature such as Anaya et
al. (2017), Bowman et al. (2014), and Tillmann (2016). In contrast, this study found
that U.S. UMP has no significant effect on Indonesia’s interest rate.

The persistence of the effects is not precisely estimated, but the point estimates
indicate that the effects “wear off,” but do so fairly slowly. Generally, the impact of
the changes in U.S. daily bond yield on Indonesia’s stock price and exchange rate
lasts for 10 days. Moreover, the magnitude of the U.S. daily treasury yield become
weaker from the third until tenth days as the Indonesia’s stock price and interest
rate slightly fluctuate during such period. On the tenth days and beyond, the
impact of U.S. daily yield completely diminishes since such variables move flatter
compared to previous days. Regarding the comparison aration to among asset
purchase programs, the changes in U.S. daily bond yield during QE 1 period
strongly influenced the stock price factor compared to the other QE and MP
programs periods. In addition, the changes in U.S. daily bond yield during QE 3
period hads the effect of the a strongest magnitude on Indonesia’s exchange rate
factor.

Although the result is statistically satisfying, there is a room for improvement in for
this research. First, a future research should include domestic factors, particularly
macroeconomic data, which are is essential to portray the Indonesia economy. This
paper uses only financial variables due to the use of high-frequency data which can
limit the variety of data. Second, there is room for improvement in the model
specification. The FAVAR model to evaluate the global spillovers of U.S.
unconventional monetary policy is statistically satisfying. However, the economic
interpretation of the results must be made cautiously. Note that since the global
financial crisis in 2008, Bank Indonesia also implements the macroprudential
policy, apart from the policy rate, to maintain economic stability in the country.
Due to this policy, the empirical results produced from this research could also be
modifiedaffected by such policy.