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Estimating Interest Rate Setting Behavior in Korea: A Constrained Ordered Choices Model Approach

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  • Hyeongwoo Kim
  • Wen Shi
  • Kwang-Myoung Hwang

Abstract

We study the Bank of Korea’s interest rate setting behavior using an array of constrained ordered choices models, where the Monetary Policy Committee revises the target policy interest rate only when the current market interest rate deviates from the optimal rate by more than certain threshold values. Our models explain changes in the monetary policy stance well for the monthly frequency Korean data since January 2000. We find important roles for the output gap and the foreign exchange rate in understanding the Bank of Korea’s rate decision-making process. We also implement out-of-sample forecast exercises with September 2008 (Lehman Brothers Bankruptcy) for a split point. We demonstrate that out-of-sample predictability improves greatly for the rate cut and the rate hike decisions using standard error adjusted inaction bands.

Suggested Citation

  • Hyeongwoo Kim & Wen Shi & Kwang-Myoung Hwang, 2015. "Estimating Interest Rate Setting Behavior in Korea: A Constrained Ordered Choices Model Approach," Auburn Economics Working Paper Series auwp2015-17, Department of Economics, Auburn University.
  • Handle: RePEc:abn:wpaper:auwp2015-17
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    File URL: http://cla.auburn.edu/econwp/Archives/2015/2015-17.pdf
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    References listed on IDEAS

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    1. Hu, Ling & Phillips, Peter C. B., 2004. "Nonstationary discrete choice," Journal of Econometrics, Elsevier, vol. 120(1), pages 103-138, May.
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    Cited by:

    1. Hyeongwoo Kim & Wen Shi, 2014. "The Determinants of the Benchmark Interest Rates in China: A Discrete Choice Model Approach," Auburn Economics Working Paper Series auwp2014-12, Department of Economics, Auburn University.

    More about this item

    Keywords

    Monetary Policy; Bank of Korea; Probit Model; Robit Model; Logit Model; Target RP Rate; Interbank Call Rate; Taylor Rule;

    JEL classification:

    • C51 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Construction and Estimation
    • C52 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Evaluation, Validation, and Selection
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies

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