Economic policy refers to the actions of the state in defining its objectives and using appropriate instruments to achieve them. The objectives of government in this regard are high long-run economic growth, equitable distribution of income and wealth, and stable prices and output. Macroeconomic policies, represented by monetary and fiscal policies, are just those intended to stabilise prices and output. This chapter begins by examining historically how these policy objectives have been addressed by the Korean government, and, against this backdrop, looks at the goals of macroeconomic policy, and especially monetary policy in Korea.

To carry out monetary policy properly, central banks prepare a strategy through which they attain their goals. Initially, the BoK set its priority on stabilising exchange rates and maintaining a balance of payments surplus, but this goal was gradually overshadowed by the goal of price and output stability. Accordingly, the BoK shifted its strategy from exchange rate and monetary targeting to inflation targeting. This chapter examines the historical development of the monetary policy strategies in Korea, and the current monetary policy framework adopted by the BoK.

Financial markets are subject to constant shocks, which can lead to crises when markets fail. Theoretically, the government can prevent such market failures. In practice, however, crises are often caused or amplified by government failure. This was particularly the case for the 1997 currency crisis in Korea. Not only did the Korean government’s inappropriate intervention trigger the crisis, but its inappropriate policy responses further transformed the initial mistakes into an economic disaster. This stands in sharp contrast to the government’s responses to the 2008 global economic crisis and the 2020 COVID-19 pandemic. This chapter overviews the roles played by the Korean government during these three crises.

If wages and prices are flexible enough, money can be neutral in the long term and has little impact on business fluctuations. In the short term, however, money can affect national output and employment because wages and prices are rigid. This chapter looks at the effect of money on prices and on short-term economic fluctuations in Korea. Finally, the chapter examines the relationship (Phillips-curve relationship) between inflation and output in Korea.

Ensuring the stability of Korea’s financial system has been an important goal of the BoK. The competence for maintaining financial stability through the appropriate micro-prudential measures has, however, always rested with the government and thus the BoK was not able to implement a financial stability policy separately. In the wake of the 2008 global financial crisis, however, this situation has changed and led to the adoption and development of macro-prudential policies by the BoK. This chapter looks at how macro-prudential policy is implemented in Korea.

The BoK has developed three monetary policy tools, to wit, the lending facility, the required reserve system, and open market operations, which have led to changes in its assets and liabilities. The BoK uses these tools to influence intermediate targets, such as the money stock and interest rates, and to achieve price stability as its final goal. It has also added to its existing toolbox a standby facility, which has gained in importance under the current interest-rate-setting monetary policy framework. This chapter looks at the main components of the assets and liabilities of the BoK, and examines its credit and monetary policy tools.

Inflation targeting was a very important operational tool in stabilising the inflation rate in many countries when the inflation rate was running high. Korea was no exception to the deployment of this tool. In the past, Korea suffered from relatively high inflation rates and the introduction of inflation targeting contributed to stabilising inflation through the anchoring of the inflation expectations of private agents. The BoK set the target at 3 per cent and focused its operations on reducing inflation to below the target and thus the inflation targeting operations carried out by the BoK were asymmetric. This chapter conducts an assessment of the inflation targeting that Korea has experienced in the aftermath of the 1997 currency crisis.

As Korean growth slows down and interest rates fall close to zero per cent, the limits of the existing interest rate-based monetary policy become apparent and unconventional policy tools and instruments need to be newly developed. Against this backdrop, this chapter looks at the future challenges which will confront the BoK, and examines how the implementation of monetary policy can be improved by incorporating tools such as quantitative easing, forward guidance, and credit easing, in order to cope with the projected low growth and low inflation.

Monetary policy in Korea is implemented by, and is the responsibility of, the Bank of Korea. More precisely, it is the Monetary Policy Board (MPB), an autonomous administrative agency modelled after the Board of Governors of the Federal Reserve System in the United States, which determines monetary policy through collective decisions. This monetary policy system was only established when the Bank of Korea became independent in 1998. This chapter looks at the history, organisation and decision-making structure of the BoK and its relationship with the Korean government.

This chapter examines the evolution of monetary standards in Korea, through which commodity money is replaced by paper money, and then paper money by electronic and digital payment instruments.