There and Back Again: Examining the Monetary Policy Regimes of South Korea with BDSGE Methods

Abstract

This paper examines how the monetary policy conduct of the Bank of Korea differed between its monetary policy regime, measured with data from 1976-1996, and its inflation targeting regime, measured from 2000-2019. Delineated by the Asian financial crisis, this regime switch encapsulates questions of optimal monetary policy, the behaviors of central banks, and the empirical methods used to analyze historical data. It seeks to answer these queries by fitting South Korean data to a DSGE model based on Gali and Monacelli (2005) and estimating this model using Bayesian methods. It finds that the monetary targeting regime of South Korea was characterized by a stronger response to inflation and the exchange rate than that of the inflation targeting era. It also uses model fit analysis to compare different specifications of the DSGE model, finding that an inflation targeting rule without the exchange rate best characterizes the Bank of Korea's behavior. However, it also finds that exchange rate targeting, or a managed float, was more characteristic of the monetary targeting era, while exchange rate smoothing was more likely to have entered the policy function of Korea's inflation targeting regime.