Do Islamic Bank Financings Drive Real Economic Activity and Price Stability? Empirical Evidence from Indonesia Using ARDL-ECM Framework

Abstract

This study investigates the dynamic relationships among price stability, real-sector activity, BI-rate, and Islamic bank financing in Indonesia using an ARDL-ECM approach on monthly data spanning January 2020–December 2023. Industrial Production Index (IPI) and Consumer Price Index (CPI) (level) are used to represent real activity and prices, while total outstanding Islamic bank financing and the BI policy rate serve as explanatory and policy control variables. Bounds testing confirms a long-run cointegration among the series. Long-run estimates indicate statistically significant and positive associations between industrial activity, policy rate, Islamic financing and the equilibrium relationship under study. Short-run coefficients are generally insignificant and the error-correction term is weakly signed and not statistically significant, implying slow or muted short-run adjustment toward the long-run equilibrium. Diagnostic checks (normality, no serial correlation, homoscedasticity, CUSUM/ CUSUMSQ) support model validity. Results suggest Islamic financing plays a meaningful long-term role in macro dynamics, but policymakers should coordinate supply-side measures to avoid potential short-run trade-offs.