Monetary and Fiscal Policies

The relaxation of monetary policy helped to attenuate the impact of the world economic slowdown in 2001 on Korea and lay the foundation for the recovery that began in the final quarter of that year. At the same time, inflation has been kept within the annual target zone. Fiscal policy, meanwhile, played a mildly supportive role with increased government spending focused on the priority of expanding the social safety net. With economic growth picking up to 6 per cent in the first three quarters of 2002, macroeconomic policy has shifted to a more neutral stance. Indeed, the Bank of Korea, which had a medium-term inflation target of 2.5 per cent, increased the policy interest rate in May 2002 (Figure 13), in the context of double-digit wage hikes and a surge in housing prices. However, there has been no further tightening of monetary policy since then in the context of the uncertain world economic outlook and the sharp appreciation of the won in the second quarter of 2002. Meanwhile, fiscal consolidation has become a priority, given the cost of financial-sector restructuring. This chapter begins by examining monetary policy and exchange rate developments, and then discusses fiscal policy issues.