Detailed Explanatory Notes

* This is an unofficial translation prepared by the Bank of Korea's staff based on the original notes released on 12 March 2026.

1. Policy Objectives

The Bank conducts monetary policy pursuant to the purpose provisions set out in Article 1, paragraphs 1 and 2 of the Bank of Korea Act (hereinafter the “BOK Act”).

Article 1, paragraph 1 of the BOK Act stipulates that the Bank shall contribute to the sound development of the national economy by pursuing price stability through the formulation and implementation of monetary policy, thereby establishing that the primary objective of monetary policy is price stability.

Paragraph 2 provides that the Bank shall pay attention to financial stability in carrying out its monetary policy, thereby presenting financial stability as an additional objective to be duly considered in the conduct of monetary policy.

The Bank sets specific targets and objectives consistent with these legal mandates, and carries out monetary policy accordingly, while striving to enhance the transparency, predictability and effectiveness of its monetary policy in the process.

2. Inflation Targeting

Price stability means a condition in which inflation is maintained at a stable and appropriate level so that economic agents are able to make decisions about economic activities without placing undue weight on price developments. Stable prices support sustainable and stable economic growth by facilitating rational decision-making and improving the efficiency of resource distribution.

The Bank conducts monetary policy under the inflation targeting system in order to achieve price stability efficiently. Under the system, a specific inflation target is announced in advance and monetary policy is carried out to achieve this target. Most major advanced economies have adopted this system.

The inflation target is currently set at 2% in terms of consumer price inflation (year-on-year). The inflation target of 2% is a level deemed appropriate taking into account the adverse effects of both high and low inflation, the underlying inflation trends, and practices of major advanced economies. Excessively high inflation could intensify economic uncertainty or distort resource allocation. By contrast, extremely low inflation could weaken economic vitality and limit the scope for policy responses. For these reasons, most of the advanced economies set the inflation target at 2% as well.

The Bank conducts its monetary policy in a way that ensures that inflation converges to the target level on the medium-term horizon, taking into account the factors and persistence of price fluctuations, as well as lags in monetary policy transmission.

Consumer price inflation can exhibit high volatility in the short term, affected by various factors, including both demand and supply. In particular, as supply-side factors, such as international oil prices and agricultural product prices, tend to be more volatile than demand-side factors, and monetary policy has only limited impact on them, a mechanical response to supply-side shocks may instead amplify volatility in both the economy and inflation. Therefore, rather than responding to short-term price fluctuations, it is important for monetary policy to assess the persistence of price shocks over the medium- to long-term horizon and to respond by taking into account changes in the underlying inflation trends based on the assessment.

In addition, the medium-term horizon reflects the existence of lags through which the effects of monetary policy are transmitted to prices. Adjustments to the Base Rate affect market interest rates, asset prices, exchange rates and credit conditions, which are then transmitted to growth and prices. According to the Bank’s macroeconometric models, the adjustment of the Base Rate is estimated to have the greatest impacts on growth after four to six quarters, and on inflation after six to eight quarters on average. However, these lags are based on estimates of average effects observed in the past, and the actual lags of monetary policy can vary significantly depending on the characteristics, size, and persistence of economic shocks and policy conditions at home and abroad.

The Bank conducts its monetary policy preemptively based on economic outlooks derived from diverse information variables to ensure that inflation converges to the target level. And the Bank adjusts its policy by examining the assumptions of economic outlooks, changes in forecasts, and policy effects. These forward-looking operations are essential for enhancing policy effectiveness as the effects of monetary policy are transmitted with lags.

The likelihood of inflation converging to the target level is assessed comprehensively by taking into account the trends in various price indicators including inflation expectations, as well as growth outlooks. Inflation expectations influence actual inflation through wage negotiations or firms’ price-setting behaviors. Even if inflation temporarily deviates from the target, stable inflation expectations can serve as an anchor, helping inflation to converge back to the target level. On the other hand, if inflation expectations are unanchored, the effectiveness of monetary policy in stabilizing prices may be weakened, delaying the pace and timing of inflation converging to the target level. Therefore, the stabilization of inflation expectations is not only a key criterion for assessing the likelihood of convergence to the target level, but also an important precondition for the effective functioning of the inflation targeting system.

In addition, the Bank symmetrically considers the risks of inflation remaining above or below the target. This reflects the consideration that both persistently high inflation and, conversely, excessively low inflation can undermine economic stability and social welfare.

The Bank operates its inflation targeting system in a flexible manner, taking into account not only inflation but also other policy variables such as economic growth and financial stability.

Since monetary policy has a broad impact on the overall economy—including not only inflation but also growth and financial stability—it is beneficial for overall economic welfare to operate policy flexibly, taking into account the trade-offs among policy variables, rather than to respond rigidly with a sole focus on price stability.

However, flexible operation does not mean that inflation and other policy variables are given equal weight. Rather, it refers to a policy approach that places top priority on price stability over the medium-term, while adjusting the intensity of policy measures in accordance with the degree of trade-offs among policy variables, or taking action to ensure the stability of other policy variables.

For example, if it is anticipated that financial stability or growth will be significantly compromised in the process of raising (or lowering) the Base Rate to bring inflation back to the target level, the size and pace of such policy rate adjustments should be managed flexibly. Furthermore, even in a situation where prices are stable, monetary policy responses may be considered if financial imbalances accumulate or upward (or downward) pressures on the output gap increase, as these factors could ultimately undermine price stability.

Because such flexible operation achieves price stability by taking into account various policy variables in a comprehensive manner, it constitutes one of the key rationales for conducting inflation targeting over the medium-term, alongside factors such as short-term volatility in inflation and lags in monetary policy transmission.

3. Consideration of Financial Stability

Financial stability refers to a state in which the financial system operates smoothly, with financial institutions performing their financial intermediary functions without disruption, market participants maintaining confidence, and credit and asset prices not deviating significantly from economic fundamentals.

A stable financial system is a necessary precondition for the effective transmission of monetary policy to the real economy and a key foundation for sustainable and stable economic growth. Accordingly, the Bank conducts its monetary policy while taking financial stability into account in the course of pursuing price stability.

Financial instability refers to a situation in which risk aversion spreads rapidly across financial and foreign exchange markets, leading to sharp increases in market interest rates, credit crunch, steep declines in asset prices, and heightened exchange rate volatility, thereby impairing the financial intermediary function of the market.

Monetary policy primarily affects price variables in financial markets, such as short- and long-term interest rates, and changes in these variables are transmitted to the real sector, including economic growth and inflation. Accordingly, when the financial markets, serving as the transmission channels, are unstable, the effectiveness of monetary policy may be constrained. In addition, financial market stress can impair the efficiency of resource allocation within the economy and dampen investment and consumption sentiment, thereby undermining overall macroeconomic stability.

Korea’s foreign exchange market adopts a free-floating exchange rate regime, where the exchange rate is in principle determined autonomously by market forces. However, excessive volatility in the exchange rate may adversely affect domestic financial stability and inflation through channels such as reduced foreign currency liquidity, deterioration in the financial soundness of firms and financial institutions, and increases in import prices.

Accordingly, the Bank seeks to prevent the accumulation of risks to financial stability, while also making efforts to ensure the rapid stabilization of financial and foreign exchange markets and the early restoration of financial intermediary functions through market stabilization measures in the event of financial instability due to unexpected shocks.

Financial imbalances refer to a state in which asset prices rise sharply or credit expands rapidly in a manner that deviates excessively from economic fundamentals. When such imbalances, manifested in the buildup of debt and overvaluation of asset prices, persist, they can constrain economic activity, amplify economic volatility, and ultimately undermine macroeconomic stability.

An appropriate level of debt can have positive effects on the economy by facilitating efficient allocation of resources between the present and the future. However, excessive debt raises the burden of principal and interest repayments, constraining consumption and investment. Moreover, if credit becomes concentrated in low-productivity sectors such as real estate, it may weaken the economy’s growth potential in the long term.

In addition, overvalued asset prices may undergo abrupt and sizable corrections in the event of economic shocks. This can trigger a vicious circle of declining consumption and investment, further economic contraction, and additional asset price declines, thereby exacerbating volatility in both the financial sector and the economic activity.

Accordingly, in the conduct of monetary policy, the Bank needs to remain attentive to the risks of such financial imbalances. In particular, once financial imbalances are formed, they are difficult to address and their adjustment process can entail substantial economic costs. Thus, it is important to take preventive measures to avoid excessive accumulation.

To this end, the Bank regularly holds Financial Stability Meetings to assess financial stability conditions and publicly discloses the results, which are then reflected in the conduct of monetary policy.

However, monetary policy affects not only financial stability but also the whole economy, including the real sector, and financial stability itself is influenced by a range of factors such as regulatory and supervisory policies and real estate policies. As such, there are inherent limitations to achieving financial stability solely through monetary policy. Therefore, to curb the buildup of financial imbalances, it is necessary to ensure a well-coordinated policy mix, between monetary policy and macroprudential policy.

4. Policy Tools and Communication

The Base Rate is the policy rate that serves as a benchmark in transactions between the Bank and financial institutions. It is used in repurchase agreement (RP) transactions as well as in the Bank’s Liquidity Adjustment Loans and Deposits. Adjustments to the Base Rate have immediate impacts on very short-term market interest rates, such as the overnight call rate, which in turn lead to changes in short- and long-term market interest rates, as well as deposit and lending rates, ultimately affecting the real economy.

Short-term policy rates, such as the Base Rate, can be adjusted directly by the central bank and are transmitted rapidly to various price variables in financial markets. They are also closely linked to policy objectives such as price stability and financial stability. Owing to these characteristics, most major central banks use policy rates as their primary monetary policy instruments. Likewise, with the adoption of the inflation targeting system in 1998, the Bank shifted its operational framework of monetary policy from a monetary aggregate-oriented to an interest rate-oriented.

However, interest rate policy alone may not be sufficient to effectively address situations in which trade-offs among policy variables intensify due to financial and foreign exchange market instability or the buildup of financial imbalances, or where the real economy contracts sharply in times of economic crisis. In such cases, the Bank employs a range of policy tools, including open market operations, lending and deposit facilities, reserve requirements, and foreign exchange market stabilization measures.

Communication refers to the set of activities through which the central bank explains to economic agents its policy objectives, the background to its decisions, and the future direction of operation, in the course of conducting monetary policy. As an institution that independently carries out its legally mandated responsibilities, the central bank has a corresponding obligation to explain its policy decision-making process as clearly as possible.

Moreover, transparent and detailed communication enhances policy effectiveness by helping economic agents form rational expectations. Monetary policy is transmitted to the economy not only through adjustments to the Base Rate, but also through channels in which changes in expectations regarding future policy paths and inflation influence the financing, consumption, and investment behavior of economic agents. Therefore, to enhance policy effectiveness, it is important to provide detailed explanations of the economic outlook, the background to policy decisions, and the future direction of policy, thereby ensuring that market expectations remain closely aligned with the central bank’s policy intentions.

In line with this, the Bank continues its efforts to enhance policy transparency by utilizing various communication channels so that economic agents can better understand the conduct of monetary policy and form reasonable expectations about its policy direction. It provides detailed information on policy decisions through policy statements, conditional Base Rate projection, minutes of the Monetary Policy Board meetings, press conferences, and the Monetary Policy Reports. In addition, by releasing various research publications, including the Korea Economic Outlook and the Financial Stability Report, the Bank shares its assessment of policy conditions with economic agents. Furthermore, it is expanding its communication channels through digital platforms, such as social media and online video content, to help the general public better understand economic conditions and the intent of its policies.