Macroeconomic Stability and Monetary Policy in Korea: Time-Varying Coefficient VAR Approach

Abstract

The post-global financial crisis (GFC) macroeconomic dynamics in Korea displays diminished output and inflation variability with a slowdown in real activity, compared to the first decade of the 2000s. This paper investigates these two distinctive macroeconomic features in Korea by estimating a vector autoregressive (VAR) model in which the VAR coefficients as well as the covariance matrix of its reduced-form innovations are allowed to change over time. Based on the data from 2000:Q1 to 2018:Q2, our objectives are twofold: (1) to unveil the source of the reduced macroeconomic volatility in Korea since the aftermath of the GFC; and (2) to inspect how the efficacy of monetary policy innovations in stimulating real activity has evolved over time. Our results indicate that the volatility of exogenous disturbances hitting the economy has declined precipitously during the sample period, which is the main driver of the recent volatility reduction in the macro aggregates. In addition, we find that the responsiveness of output toward monetary policy innovations has decreased gradually since the early to mid-2000s, but monetary policy remains effective in boosting output even for the most recent sample.

Keywords: Time-varying Coefficient VAR, Stochastic Volatility, Monetary Policy

JEL Classification: E32, E52, C11, C15, C22