Inflation Targeting in an Emerging Market: the Case of Korea

Michael Hanson and Kwanghee Nam ()
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Kwanghee Nam: School of Economics, Kookmin University, Jeongneung-dong

No 2005-007, Wesleyan Economics Working Papers from Wesleyan University, Department of Economics

Abstract: To evaluate the effectiveness of targeting monetary policy strategies in a small open economy, we develop a dynamic optimizing model calibrated to recent Korean data. We then explore the consequences of alternative specifications of the loss function for society and the central bank, with particular focus on exchange rate volatility. Policy simulations include variations on inflation targeting, nominal income growth targeting and exchange rate targeting. Our results indicate that inflation targeting remains the most preferred policy regime, even when an explicit motive for exchange rate smoothing is introduced. In this case, the optimal inflation targeting and nominal income growth targeting policies are characterized by a “conservative” central bank that places greater weight on both the primary target variable and on the exchange rate than in society’s objective function. However, the optimal policy reacts to changes in degree of exchange rate pass-though in a non-linear fashion, complicating the robustness of inflation targeting recommendations for emerging markets.

Keywords: Korean economy; inflation targeting; optimal monetary policy; small open economy (search for similar items in EconPapers)
JEL-codes: E52 F41 (search for similar items in EconPapers)
Pages: 22 pages
Date: 2005-09
New Economics Papers: this item is included in nep-cba, nep-mac and nep-mon
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Citations: View citations in EconPapers (1)

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