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How to Estimate the Policy Effect of Forward Guidance in the Korean Economy

  • Journal of Insurance and Finance
  • 2017, 28(2), pp.3-36
  • DOI : 10.23842/jif.2017.28.2.001
  • Publisher : Korea Insurance Research Institute
  • Research Area : Social Science > Business Management
  • Received : January 19, 2017
  • Accepted : May 18, 2017
  • Published : May 31, 2017

Donghun Joo 1

1한양대학교

Accredited

ABSTRACT

The purpose of this study is to find the way of evaluating the policy effect of forward guidance(FG) in the Korean economy. DSGE models seem to be appropriate for the FG policy evaluation as they include the expectation variables. However, the problem is that the FG puzzle appears in the conventional DSGE models. The FG puzzle means the excessive response of endogenous variables to the FG policy. Therefore, we investigate the possibility of using the forecast model of the Bank of Korea, BOKDPM, to evaluate the FG policy effect without the puzzle by applying the suggestion of McKay, Nakamura, and Steinsson (MNS, 2016) to the model. Contrary to our expectation, however, the FG policy effect barely appears rather than excessively in the BOKDPM. The probable reason is that the mean of the prior distributions for the parameters of GDP gap equation are set with too small values to obtain the forecast stability. For the expectation effect of FG to be reasonably estimated in the BOKDPM, we suggest the model to be estimated with Bayesian method using the prior distribution of interest rate coefficient where the mean is set at the conventional risk aversion coefficient and that of GDP expectation where the mean is set at around the current value so that the equation is similar to the MNS(2016)'s discounted IS curve.

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