Korea's Neutral Interest Rate: Estimates, Determinants, and Monetary Policy Stance

A neutral interest rate is a key indicator of the monetary policy stance. This study estimates South Korea’s neutral interest rates and their determinants. Based on the results, we investigate the prior monetary policy patterns of the Bank of Korea (BOK) and evaluate its stance. We adopted a time-series model approach, with a Bayesian econometric strategy. We can summarize the empirical findings as follows. First, the neutral interest rate has continued to fall, and it tends to fall sharply during downturns, such as the global financial crisis and COVID-19 pandemic. Second, the fall over the past two decades is largely attributable to population aging and the neutral US interest rate. Meanwhile, the recent rebound in the neutral interest rate seems to be due to the increase in the net issuance of government bonds. Finally, the BOK responded substantially to aggregate demand shocks over recent decades. In particular, the BOK’s current monetary policy stance is contractionary because of its active response to inflation rather than real activity.