The External Influences on Korea's Monetary Policy
The main purpose of this study was to investigate the external influences on Korea’s monetary policy over the period from 1990 to 2020. The focus was on the effects of US interest rates, payments imbalances and exchange rate changes on Korean monetary policy.Two types of measures of Korean monetary policy were considered. These are the effects on Korean interest rates and the effects on the domestic money supply and monetary base. The purpose in estimating the basic Taylor rules was to go beyond unconditional estimates of pass through from US to Korean interest rates and to attempt to control for domestic influences on Korean interest rates. This gave us better estimates of the actual influences of the US interest rate and exchange rate changes by controlling for Korean interest rate changes that would have occurred even without the foreign developments. Correspondingly, the estimation of sterilization and offset coefficients by a set of simultaneous equations attempted to control for domestic as well as external influences on its money supply. Estimating both the Taylor rule and sterilization/offset coefficients together could give a better idea of the patterns of Korean responses. The Global Financial Crisis (GFC), during 2007-2008, was chosen as a structural break point. The empirical tests of the Taylor rule implied that the impact of the US interest rate on Korean policy rate has been steady but weak throughout most circumstances. On the other hand, the impact of the exchange rate on Korean policy rate had varied before and after the GFC. The analysis of the Bank of Korea (BOK) monetary policy reports explained the different impacts that the exchange rate has had on Koren policy rate before and after the GFC. The reports indicated that the overall balance of payments, in the aftermath of the Asian Financial Crisis, has been a main concern of Korean monetary authority while the status of domestic economy has been a main factor contributing to the impact that the exchange has had on Korean policy rate during the postcrisis period. The test results from the Sterilization and Offset study showed almost perfect sterilization of reserve changes resulting from intervention in the exchange market. Since the offset coefficients, close to 1, were overstated, the results from the interest rate passthrough model were used as a measure of capital mobility. It was found to be imperfect. Overall, Korea has had a fairly open capital account, managed floating exchange rate regime and independent central bank. Korean monetary policy has been influenced by monetary developments in the US, but it still has had a good deal of independence.
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