This paper estimates the monetary policy reaction function in Korea after
1999 when the Bank of Korea started to announce a policy interest rate under
inflation targeting. In particular, we focus on a change in the monetary policy
reaction function before and after the global financial crisis in terms of the
reactions to inflation pressure and GDP gaps. The empirical results based on
the GMM and 2SLS estimation methods are summarized as follows. The policy
rate responds with significance to GDP gaps but not to inflation pressure
expected to occur in the following 12 months, both before and after the global
financial crisis. This behavior appears to be consistent when the US monetary
policy rates and/or the real exchange rate is included in the estimation. The
policy rate is estimated to respond more to GDP gaps during recessions than
during expansions while there is no significant difference in the monetary
policy reaction function between under positive inflation pressure and under
negative inflation pressure. From the estimation using various time horizons
for estimating inflation pressure from the past 12 month period to the future 12
month period, the policy rate tends to respond to the past 12 month period
and the one-month ahead inflation but not to the longer future expected
inflation, which implies that the rate decision is not preemptive.