The effects of unconventional monetary policy in Korea

Abstract

This thesis analyzes effectiveness of unconventional monetary policy mainly using the approach of New-Keynesian DSGE model which incorporates financial friction. Specifically, Dynamic Stochastic General Equilibrium model explicitly incorporating financial intermediaries like Gertler and Karadi (2011) and Gertler and Karadi (2013) are broadly utilized in the whole part of this thesis. Parameters are usually calibrated using Korean statistics and relevant literatures. Conceptually, in this thesis, enlarging monetary base through large scale asset purchase (LSAP) or foreign exchange intervention (FXI) is defined as typical monetary policy tool used in the implementation of unconventional monetary policy. Furthermore, the relationship between conventional and unconventional monetary policy is also examined in terms of the preferred habitat approach.

In chapter 3, applying Gertler and Karadi (2011) typed New-Keynesian DSGE model into Korean economy, the effectiveness of credit policy is analyzed for the two types of financial shocks. The two types of financial shock are negative capital quality and negative bank net worth shock. Simulation results suggest that credit policy intervention contributes to moderate economic contraction, regardless of negative capital quality shock or bank net worth shock. In chapter 4, it proves that for emerging market economies including features of a small open economy, effectiveness of unconventional monetary policy like the intervention in domestic credit or in foreign exchange market can be very different according to the source of shock during the crisis. Regarding to negative global interest rate shock originated in external sector, it proves that the intervention in foreign exchange market can be more effective than the intervention in domestic credit market in moderating fluctuations of output and inflation. On the other hand, for negative capital quality or bank net worth shock originated in the domestic economy, it turns out that the intervention in domestic credit market is slightly better than the intervention in foreign exchange market in terms of policy effectiveness. In chapter 5, the effectiveness of two monetary policies such as traditional interest rate adjustment and the foreign exchange market intervention using foreign reserve are analyzed based on the model by Aoki, Benigno, and Kiyotaki (2016) which is the open economy version of Gertler and Karadi (2011). It seems that appropriate foreign exchange intervention using foreign reserve can be helpful in boosting inflation and output overall during the downturn. Simultaneously, it also proves that as the intensity of the intervention is stronger, as policy effectiveness is also bigger.

In chapter 6, theoretical differences in policy effectiveness are analyzed in term of three perspectives applying Gertler and Karadi (2013) typed New-Keynesian DSGE model into Korean economy. According to policy simulations, it proves purchase of private securities can be more effective than purchase of long-term government securities when it comes to stabilizing financial market distress and boosting real activities. The result of policy experiment also demonstrates that asset purchase can be more effective when the zero lower bound constraint is maintained for some periods than when the nominal policy rate can be adjusted flexibly in reaction to an asset purchase shock. Finally, the policy effectiveness of an asset purchase can also become weaker when it is postulated that the household cannot directly hold any financial assets like long-term private securities and government securities. In chapter 7, the relationship between conventional and unconventional monetary policy is examined through the approach of “preferred habitat model” of Ellison and Tischbirek (2013) which includes characteristics of canonical New-Keynesian DSGE model. According to optimal monetary policy analysis, it proves that conventional monetary policy instrument like adjustment of short-term nominal policy rate can be harmoniously utilized as a complement with unconventional monetary policy like an asset purchase even though the policy rate is not restricted at zero lower bound. In addition, it also turns out that conducting conventional and unconventional monetary policy together can be considerably contributed to minimize the loss which is composed of the volatilities of short- or long-term government security interest rates.

In sum, considering all the comprehensive simulation results, such a conclusion can be derived that if Bank of Korea conducts unconventional monetary policy utilizing some policy instruments such as asset purchase or foreign exchange intervention, it would be able to considerably contribute to protect the collapse of abrupt financial intermediation in crisis and boost real activities in a deflationary environment. At the same time, it is also evident that according to the characteristic of each exogenous shock, proper unconventional monetary policy instrument under each specific economic situation can be largely different. Hence, in terms of this stance, Bank of Korea would have to be more careful in choosing the non-traditional monetary policy tool when they decide to conduct unconventional monetary policy actively in the future downturn. Furthermore, considering complementarity of conventional and unconventional monetary policy, it seems to be possible the Central Banks in emerging market economies are able to routinely use unconventional monetary policy instrument with traditional adjustment of short-term policy rate in normal time, not just in crisis, although policy rate is not restricted to zero lower bound.

Date of Award	22 Jul 2020
Original language	English
Awarding Institution	University of Bath
Supervisor	Christopher Martin (Supervisor) & Vito Polito (Supervisor)