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<p>This study provides robust evidence on how the choice of the policy instrument for monetary policy influences its impact on economic activity. We study the case of South Korea for the period 1980-2017. We use FAVAR models that allow a comprehensive exploration of different areas of economic activity by overcoming limitations on a number of variables that can be included in the analysis in a traditional VAR model. Following the actual use of instruments, we test the effectiveness of monetary policy in two separate periods: 1980-1999, when the Bank of Korea mostly used M2 as the policy instrument; and then 2000-2017, when interest rate was the policy instrument. Our results show that monetary policy that uses interest rate as the policy instrument is markedly more effective in economic activity than M2. This is observable in the reaction from prices as well as variables that measure industrial production. In contrast, the impact of M2 mostly occurs in prices and it is short lived. We use robustness checks that switch the use of instrument for each subperiod and also test the use of each policy instrument for the entire period of analysis. The results hold, interest rates as policy instrument of monetary policy are more effective than M2.</p>
</abstract>

This study provides robust evidence on how the choice of the policy instrument for monetary policy influences its impact on economic activity. We study the case of South Korea for the period 1980-2017. We use FAVAR models that allow a comprehensive exploration of different areas of economic activity by overcoming limitations on a number of variables that can be included in the analysis in a traditional VAR model. Following the actual use of instruments, we test the effectiveness of monetary policy in two separate periods: 1980-1999, when the Bank of Korea mostly used M2 as the policy instrument; and then 2000-2017, when interest rate was the policy instrument. Our results show that monetary policy that uses interest rate as the policy instrument is markedly more effective in economic activity than M2. This is observable in the reaction from prices as well as variables that measure industrial production. In contrast, the impact of M2 mostly occurs in prices and it is short lived. We use robustness checks that switch the use of instrument for each subperiod and also test the use of each policy instrument for the entire period of analysis. The results hold, interest rates as policy instrument of monetary policy are more effective than M2.

Does the Effectiveness of Monetary Policy Depend on the Choice of Policy Instrument? Empirical Evidence from South Korea

Journal of Central Banking Theory and Practice

This work is licensed under the Creative Commons Attribution 4.0 International License.

This study provides robust evidence on how the choice of the policy instrument for monetary policy influences its impact on economic activity. We study the...

Does the Effectiveness of Monetary Policy Depend on the Choice of Policy Instrument? Empirical Evidence from South Korea

Published Online: May 24, 2023

Page range: 239 - 265

Received: Jun 05, 2022

Accepted: Nov 21, 2022

DOI: https://doi.org/10.2478/jcbtp-2023-0021

Keywords
monetary policy, policy instrument, VAR, FAVAR, impulse response function

© 2023 Martha Cruz Zuniga et al., published by Sciendo

This work is licensed under the Creative Commons Attribution 4.0 International License.

Does the Effectiveness of Monetary Policy Depend on the Choice of Policy Instrument? Empirical Evidence from South Korea

Published Online: May 24, 2023

Page range: 239 - 265

Received: Jun 05, 2022

Accepted: Nov 21, 2022

DOI: https://doi.org/10.2478/jcbtp-2023-0021

Keywordsmonetary policy, policy instrument, VAR, FAVAR, impulse response function

© 2023 Martha Cruz Zuniga et al., published by Sciendo

This work is licensed under the Creative Commons Attribution 4.0 International License.

Keywords
monetary policy, policy instrument, VAR, FAVAR, impulse response function