NONLINEAR MONETARY POLICY REACTION WITH ASYMMETRIC CENTRAL BANK PREFERENCES: SOME EVIDENCE FOR KOREA

Abstract

The paper considers asymmetric central bank preferences and nonlinear AS curve in the monetary policy reaction function to examine nonlinear property of monetary policy rules. The optimal monetary policy rules are derived in a new Keynesian macroeconomic framework where the central bank has the asymmetric objective function. The derived reaction function explains the nonlinear reaction to the inflation gap and the output gap. The nonlinear reaction function is applied to explain the determination of the interest rate in Korea for the sample period of inflation targeting September 1998 to December 2005. The empirical evidence supports that the objective of the central bank is asymmetric in inflation management. The evidence of asymmetric reaction to the output gap is relatively weak. The empirical analysis reveals that the central bank responds strongly to the positive inflation gap compared to the negative inflation gap.