Group :
TITLE : [Economic Papers 5-2]
The Effect of
Uncertainty on Monetary Policy in Korea
AUTHOR : Min Chang and Jean
Lim
CONTACT : Institute for Monetary & Economic
Research
(tel: 82-2-759-5407, 5421 fax: 82-2-759-5410)
ATTACH :
EP5-2-01.pdf
Summary:
With the introduction of an inflation targeting regime after the currency
crisis, the Bank of Korea shifted the emphasis of monetary policy from monetary
aggregates to interest rates. Under this monetary policy regime, in case that
the deviation of inflation from a target range is predicted by observing various
information variables, it is important for central banks to adjust policy rates
preemptively. Therefore, the central bank must be capable of forecasting the
future economic situation. In reality, however, since the future economy is
uncertain and greatly affected by various factors, there are many difficulties
in forecasting the future economic situation in order to carry out monetary
policy effectively. The paper sets out both to track an optimal call rate path
by introducing multiplicative uncertainty to an economic model, and to analyze
empirically the effect of uncertainty on monetary policy in Korea. The result is
that if uncertainty is present, it is desirable to operate an interest rate
policy gradually. It also shows that the path of the actual call rate is similar
to that of the optimal call rate under multiplicative uncertainty. In short, if
the monetary authorities implement monetary policy taking future uncertainty
into consideration, interest rates will adjust gradually, even though interest
rate smoothing is not an objective of monetary policy.