Chapter 5: The monetary policy response to the crisis
1 Dongchul Cho INTRODUCTION Korean history will probably record the last three years of the twentieth century as a period of dramatic economic policy experiments. Reforms affected virtually the entire economy, from ﬁnancial and labor markets to the corporate and government sectors. Macroeconomic policy was no exception. Immediately following the outbreak of the crisis, the ﬁscal authority decided to mobilize funds totaling more than 12 percent of GDP for purposes of ﬁnancial sector restructuring. But this was nothing compared to the revolution in monetary policy. In November and December 1997, when the currency crisis was triggered, stabilization of the exchange rate had been the foremost policy objective. Before the crisis, the ﬂuctuation of the currency was limited to a narrow range, and a variety of restrictions were maintained on capital inﬂows and outﬂows. The crisis led to a complete change: the exchange rate was allowed to ﬂoat freely, and the capital account was liberalized. Inﬂation targeting was introduced as a legal mandate, and the intermediate target of monetary policy was shifted from the monetary aggregates such as M2 to short-term interest rates.2 Perhaps the most dramatic and controversial aspect was interest rate policy. Overnight interbank call rates were raised to more than 30 percent from the previous level of 12 to 13 percent in order to attract capital inﬂows and limit outﬂows. Partly in response, the GDP growth rate plunged to –8 percent (year-on-year) in the second quarter of 1998, and the unemployment rate skyrocketed...
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