Inspecting Business Cycles in Korea through the Lens of the TANK Model

This paper extends the small open new Keynesian model in Galí and Monacelli (2005) by incorporating financial frictions with constrained households into the model to explore the sources of business cycles in Korea since the mid-1970s. The estimated model via maximum likelihood shows a substantial fraction of constrained households whose variation plays a pivotal role over business cycles in Korea. The contribution of the foreign productivity shock to the fluctuation of output has decreased over time, while the relative importance of the domestic factor in business cycles in Korea has increased. The monetary policy, which has been very loose to accommodate the high demand for liquidity during a high economic growth era, became proactive in controlling inflation after the Asian financial crisis as the Bank of Korea adopted the inflation targeting rule in 1998.