Author(s): Aula Ahmad Hafidh Saiful Fikri, Sharifah Faigah Syed Alwi, Ruhaini Muda
This paper investigates the interdependent relationship of inflation, monetary policy and Islamic banking variables in Indonesia using the Structural Model of Vector Autoregression (SVAR). The study makes use of inductive and econometrical methods to analyze Islamic Banking variables in influencing the economic activity and monetary policy. The study utilizes time series monthly data for the period of 2001M01 until 2019M12. The empirical results of Structural VAR illustrate that policy shocks have a negative impact on all variables in Islamic banking except the equivalent deposit interest rate (RDEP). The impact of both conventional Bank Indonesia rate/7days Repo Rate (7DRR) and Bank Indonesia certificates sharia (SBIS) policies have a similar pattern, while the transmission of sharia monetary variables as a policy operational target in influencing inflation is positive. In addition, the Forecasting Error Decomposition Variation (FEDV) clearly reveals that the variation in the sharia financial sector is relatively large in monetary policy shocks and has significant roles in influencing prices. The study aims to contribute to formulating the Islamic economic theory, through the utilization of various Islamic banking instruments to influence economic activity and its efficacy on the monetary policy. The study is a contribution to formulate the methodological framework for a paradigm of Islamic economics, where it investigates the role of the transmission mechanism of sharia banking on the money market and monetary policy, by the econometrical methods used in the conventional economy. Also, the study illustrates the importance of further studies that examine the methodological framework for Islamic Economics. It concludes that the central bank can control the monetary policy, economic activity and Islamic economy.