The Effect of Inflation Targeting Policy on Price Stability in South Korea, Utilizing Threshold Autoregressive Model

Abstract

Purpose - The purpose of Inflation Targeting (hereafter IT) Policy is price stability. To see whether IT policy has positive effects on price stability in South Korea, whether or not inflation rates are less persistent after an IT policy is explored. Design/Methodology/Approach - To estimate inflation persistence for the inflation rates within and deviated from the target range of 2% ~ 4% during the period of the post-IT policy, respectively, a Threshold Autoregressive (TAR) Model with aggregate CPI and disaggregate CPIs for 20 items is utilized. In addition, I investigate whether inflation persistence is different depending on whether the inflation rates undershoot or overshoot toward the target range. Findings - It was found that inflation persistence was reduced after an IT policy. However, there was no difference in inflation persistence depending on whether inflation rates are within and deviated from the target range of 2% ~ 4% and also whether they overshoot or undershoot toward the target range. I also found that the same results from the robustness test, which set the target range of 2.5% ~3.5%. Research Implications - The findings suggest that an IT policy has a positive effect on price stability in South Korea regardless of overshooting or undershooting toward the target ranges, which means that even if there is an economic shock in South Korea, its influence on the inflation rates would be temporary.