Your browser does not support the PubReader view.
Go to this page to see a list of supporting browsers.
Seoul Journal of Economics
[ Article ]
Seoul Journal of Economics - Vol. 19, No. 1, pp.171-197
ISSN: 1225-0279 (Print)
Print publication date 28 Feb 2006
Received 14 Sep 2005 Revised 17 Nov 2005

Inflation Targeting in a Stable Growth Economy: The Korean Experience

Junggun Oh
Deputy Director General, Institute for Monetary and Economic Research, The Bank of Korea, Seoul 100-794, Korea, Tel: +82-2-759-5441 ojunggun@bok.or.kr

JEL Classfication: E52, E58, E12

Abstract

In an economy characterized by stable growth and low inflation, the slope of a non-linear Phillips curve may become flatter. As a result, the degree of sacrifice of employment needed to reduce the inflation rate increases. Therefore, it is necessary to carry out inflation targeting monetary policy more flexibly including a careful reexamination of both the target inflation rate to restore economic growth toward full employment and of the appropriate level of interest rate to achieve the target inflation rate. The costs of reducing inflation as well as the benefits of doing so should be taken into account together in a balanced manner. An optimal target rate of inflation becomes more important in escaping from unnecessary unemployment.

In this regard, the form of the Phillips curve has important implications for monetary policy. In Korea, a non-linear Phillips curve is estimated to be concave. The estimated full employment rate of inflation (FERI) is still within the upper bound of the band of the current target inflation rate and, according to the simulation result, the level of the current rate of interest seems reasonable. Statistically, however, the output gap is only insignificantly influenced by a change in the interest rate mainly because the demand elasticity of interest rate had been almost negligible since the 1997 financial crisis. Therefore, recovering the investment elasticity of interest rates has now emerged as an important issue.

Keywords:

Inflation targeting, Nonlinear Phillips curve, Monetary policy, Korea

Acknowledgments

Paper prepared for the 13th Seoul Journal of Economics International Symposium held at Seoul National University, Seoul. September 23, 2005. The views expressed herein are those of the author and do not necessarily reflect those of the Bank of Korea.

References

  • Akerlof, George A., William T. Dickens, George L. Perry, Robert J. Gordon, and N. Gregory Mankiw. “The Macroeconomics of Low Inflation.” Brookings Papers on Economic Activity (No. 1 1996): 1-76. [https://doi.org/10.2307/2534646]
  • Apergis, Nicholas, Stephen M. Millers, Alexandros Panethimitakis, and Athanasios Vamvakidis. Inflation Targeting and Output Growth: Empirical Evidence for the European Union. IMF Working Paper, WP/05/89, May 2005. [https://doi.org/10.5089/9781451861082.001]
  • Ball, Laurence. “Policy Rules for Open Economies.” In John B. Taylor (ed.), Monetary Policy Rules. Chicago, Illinois: University of Chicago Press, pp. 127-44, 1999. [https://doi.org/10.3386/w6760]
  • Blanchard, Olivier, and Jordi Garli. Real Wage Rigidities and the New Keynesian Model. Jun. 15, 2005. [https://doi.org/10.3386/w11806]
  • Cecchetti, Stephen G., and Michael Ehrmann. Does Inflation Targeting Increase Output Volatility? An International Comparison of Policymakers' Preferences and Outcomes. NBER Working Paper No. 7426, Dec., 1999. [https://doi.org/10.3386/w7426]
  • Clarida, Richard. “The Empirics of Monetary Policy Rules in Open Economies.” International Journal of Finance and Economics 6 (October 2001): 315-23. [https://doi.org/10.1002/ijfe.168]
  • Clarida, Richard, Jordi Gali, and Mark Gertler. “The Science of Monetary Policy: A New Keynesian Perspective.” Journal of Economic Literature 37 (December 1999): 1661-707. [https://doi.org/10.1257/jel.37.4.1661]
  • Clarida, Richard, Jordi Gali, and Mark Gertler. “Monetary Policy Rules and Macroeconomic Stability: Evidence and Some Theory.” The Quarterly Journal of Economics 115 (February 2000): 147-80. [https://doi.org/10.1162/003355300554692]
  • Clifton, Eric V., Hyginus Leon, and Chorng-Huey Wong. Inflation Targeting and the Unemployment-Inflation Trade-off. IMF Working Paper WP/01/166, October 2001. [https://doi.org/10.5089/9781451858105.001]
  • Dolado, Juan J., Ramon Maria-Dolores, and Manuel Naveira. “Are Monetary-policy Reaction Functions Asymmetric?: The Role of Nonlinearity in the Phillips Curve.” European Economic Review 49 (No. 2 2005): 485-503. [https://doi.org/10.1016/S0014-2921(03)00032-1]
  • Fuhrer, Jeffrey C. "Inflation/Output Variance Trade-offs and Optimal Monetary Policy.” Journal of Money, Credit and Banking 29 (No. 2 1997): 214-34. [https://doi.org/10.2307/2953676]
  • Hagen, Jurgen von, and Boris Hofmann. Monetary Policy Orientation in Times of Low Inflation. Prepared for the Conference on Monetary Policy under Low Inflation, Federal Reserve Bank of Cleveland, Nov. 21-23, 2003.
  • Laxton, Douglas, David Rose, and Demosthenes Tambakis. “The U.S. Phillips Curve: The Case for Asymmetry.” Journal of Economic Dynamics and Control 23 (No. 8 1999): 1459-85. [https://doi.org/10.1016/S0165-1889(98)00080-3]
  • Lee, Myungwhal. An Optimal Rate of Target Inflation. Conference Proceedings on Inflation Targeting, The Bank of Korea, October 2002 (in Korean).
  • Mohanty, M. S., and Marc Klau. Monetary Policy Rules in Emerging Market Economies: Issues and Evidence. BIS Working Paper 149, March, 2004. [https://doi.org/10.1007/3-540-28201-7_13]
  • Nobay, A. R., and D. A. Peel. “Optimal Monetary Policy with a Nonlinear Philips Curve.” Economics Letters 67 (No. 2 2000): 159-64. [https://doi.org/10.1016/S0165-1765(99)00265-7]
  • Oh, Junggun. “How Useful Is an Underlying Inflation Rate for Inflation Targeting?” Economic Papers 2 (No. 2 1999a): 29-63.
  • Oh, Junggun. “Inflation Targeting, Monetary Transmission Mechanism and Policy Rules in Korea.” Economic Papers 2 (No. 1 1999b): 102-46.
  • Oh, Junggun. “Inflation Targeting: A New Monetary Policy Framework in Korea.” In Practical Experiences in Inflation Targeting, The Bank of Thailand, Bangkok, October, 2000.
  • Oh, Junggun. “Monetary and Exchange Rate Policies.” In Charles Harvie, Hyun-Hoon Lee, and Junggun Oh (eds.), The Korean Economy: Post-Crisis Policies, Issues and Prospects. Cheltenham, UK: Edward Elgar, 2004.
  • Oh, Junggun. “Korea's Post-Crisis Monetary Policy Reforms.” (with D. Park), Review of Pacific Basin Financial Markets and Policies 8 (No. 1 2005): 265-84.
  • Shin, Sukha. “Korea's Natural Rate of Unemployment: Estimates and Assessment.” KDI Journal of Economic Policy 26 (No. 2 2004) (in Korean).
  • Svensson, Lars E. O. How Should Monetary Policy Be Conducted in an Era of Price Stability? NBER Working Paper 7516, Feb., 2000. [https://doi.org/10.3386/w7516]
  • Svensson, Lars E. O. “Open Economy Inflation Targeting.” Journal of International Economics 50 (No. 1 2000): 155-83. [https://doi.org/10.1016/S0022-1996(98)00078-6]
  • Taylor, John. “The Role of the Exchange Rate in Monetary Policy Rules.” AER Papers and Proceedings 91 (No. 2 2001): 263-7. [https://doi.org/10.1257/aer.91.2.263]
  • Thornton, Daniel L. The Costs and Benefits of Price Stability: An Assessment of Howitt's Rule. Federal Reserve Bank of St. Louis, Mar/Apr., 1996. [https://doi.org/10.20955/r.78.23-38]