KDI - Korea Development Institute - RESEARCH - Research Areas

Summary

Monthly Economic Trends KDI Monthly Economic Trends 2026. 4

■	The Korean economy remained on a gradual recovery path, but downside risks increased following the war in the Middle East.

	○	Domestic demand improved modestly, while exports posted strong growth, led by semiconductors.

	-	In February, consumption sustained its recovery momentum. Equipment investment posted strong growth, led by semiconductors, while the decline in construction investment moderated.

	-	On the production side, services maintained robust growth. Manufacturing output also accelerated, supported by a surge in semiconductor production.

	○	However, downside risks intensified further in March, driven by the surge in global oil prices and deepening supply chain disruptions following the war in the Middle East.

	-	With petroleum prices rising sharply, inflationary pressures are likely to build, particularly in sectors closely linked to crude oil.

	-	Export conditions softened somewhat on weaker global demand, while heightened uncertainty may constrain the recovery in investment.

	-	Reflecting these developments, both the Composite Business Sentiment Index and the Composite Consumer Sentiment Index declined.

Summary

Policy Study KOR Evaluating Fiscal Rules over Business Cycles and Population Aging

This paper evaluates the general-equilibrium effects of escape clauses within fiscal rules in an economy subject to business-cycle fluctuations. It embeds an AR(1) total factor productivity (TFP) supply shock into a closed-economy overlapping generations (OLG) model to conduct a 70-year transition-path analysis by incorporating Statistics Korea’s projections of annual changes in population age structure and mortality. To ensure high predictive accuracy while capturing annual demographic shifts, the model employs a Krusell·Smith (1998)-type linear approximation for aggregate forecasting functions, estimated and applied on a year-to-year basis.

The escape clause is modeled as a rule that adjusts the fiscal deficit-to-GDP ratio across three TFP states. In the absence of population aging, the escape clause reduces tax volatility but increases government debt volatility. The higher debt, through crowding-out effects, raises volatility in aggregate capital and GDP, potentially amplifying the persistence of tax shocks. By contrast, the volatility of aggregate assets is mitigated in part: in booms, the escape clause increases debt, which lowers interest rates via crowding out and partially offsets asset accumulation; in recessions, the mechanism cushions against asset declines. When incorporating population aging, overall macroeconomic volatility rises, and the escape clause further magnifies fluctuations in government debt, aggregate capital, and GDP. These findings suggest that under supply shocks, fiscal easing should be limited to targeted support for vulnerable households, with escape clauses gradually narrowed as aging intensifies.

Summary

Policy Study KOR Economic Effects of Identified Exogenous Tax Policy Shocks: A Narrative Approach for Korea

This study addresses a key challenge in estimating the macroeconomic effects of fiscal policy: the difficulty of credibly identifying policy shocks. Using a narrative approach, we construct a quarterly series of exogenous tax policy shocks for Korea over 2005~2023 and use it to examine the short-run macroeconomic effects of tax policy.

The identified exogenous tax shocks exhibit a weaker association with business-cycle fluctuations than conventional measures based on observed tax revenue changes, suggesting that they may better capture discretionary policy actions rather than automatic stabilizers. We further assess exogeneity using checks based on GDP forecast errors (“surprises”), aiming to mitigate endogeneity concerns that arise when revenue fluctuations are used directly as shocks.

Empirical analysis based on a Bayesian vector autoregression (BVAR) indicates that exogenous tax cuts generally raise real GDP and prices in the short run. The effects vary across tax categories: labor tax cuts show relatively larger expansionary impacts on output, while consumption tax cuts display limited output effects despite pronounced revenue losses. Capital tax cuts tend to operate with longer lags, accompanied by relatively large short-run revenue declines. These patterns suggest that tax policy can affect the economy through heterogeneous transmission channels depending on the tax base, policy objectives, and the revenueoutput trade-offs. We also find that the response of total tax revenue after tax cuts is sometimes statistically insignificant, consistent with offsetting forces between direct revenue reductions and revenue gains induced by higher output.

Rather than offering prescriptive recommendations for specific taxes, this study provides a transparent framework for identifying and quantifying tax policy shocks and documents the relative patterns of macroeconomic and revenue responses across tax types and motivations. Important limitations remain, including residual uncertainty in narrative classifications when reforms pursue multiple objectives and the need for additional robustness analyses given the sample length and shock frequency. Future research could refine classification rules, compare alternative identification strategies, and integrate spending shocks to strengthen policy implications.

Summary

Journal of Economic Policy KDI Journal of Economic Policy, February 2026

Addressing the Demographic Decline in South Korea / DANIEL CARROLL, SEWON HUR, SELAHATTIN IMROHOROGLU, AND BRADEN STRACKMAN

In this paper, we use an overlapping-generations standard-incomplete markets model to quantitatively investigate the long-run implications of Korea’s demographic changes and policy reforms. Importantly, our quantitative model endogenizes the retirement decision and matches the elasticity of retirement to wealth. We use the model calibrated to Korea’s economy and demography as a quantitative laboratory to investigate two policy scenarios: increasing taxes or decreasing benefits. While decreasing benefits leads to greater long run activity, it comes at the cost of lower average welfare, particularly for retirees.

Can Healthy Aging Boost the Labor Supply? Evidence from Korea / BERTRAND GRUSS, ERIC HUANG, ANDRESA LAGERBORG, DIAA NOURELDIN, AND GALIP KEMAL OZHAN

This paper examines the role of ‘healthy aging’ in boosting labor supply in Korea. First, we use microdata from surveys to assess whether there is evidence that the physical abilities of individuals aged 50 years and above have been improving over successive cohorts. Second, we investigate whether health improvements among older workers influence their labor market outcomes, such as the decision to supply labor or to retire. We use an instrumental variable approach to enable causal inference, proxying exogenous variations in health with the incidence of certain chronic diseases. Our findings reveal that (i) physical health indicators have improved on average across birth cohorts, providing evidence in favor of ‘healthy aging’ in Korea, and (ii) better health increases the probability of participating in the labor force and postponing retirement. Overall, our results suggest that healthy aging increased the labor supply of older individuals in Korea by around 1.9 percentage points per year during the period 2006-20. The results for Korea are qualitatively comparable but quantitatively
somewhat stronger than those for comparator Asian countries.

Marriage and Child Penalties: Evidence from South Korea / MINSUB KIM

This paper documents marriage and child penalties in Korea, where the female labor supply remains constrained by marriage and childbirth despite the urgent need to promote the female labor supply in the face of the world’s most rapidly aging population. Using an event-study approach and nationally representative panel data, I find substantial marriage and child penalties in Korea. Unlike developed countries, Korea exhibits a significant marriage penalty that cannot be explained by childbirth-related factors. While marriage penalties declined during the 2010s, child penalties have prevailed despite the expansion of various family policies over the same period. The persistence of child penalties is discussed in relation to prevailing social norms and rigid labor market structures that limit mothers’ labor supply.

Recent Socioeconomic Differentials in Marriage Rates in Korea and China: A Comparative Study / MINHEE CHAE

This paper explores the relationship between socioeconomic status (SES) and the recent rapid decline in marriage rates in China and South Korea, using nationally representative longitudinal data. The analysis shows that recently rising never-married rates (NVMR) are increasingly concentrated among lower-SES individuals, especially in highly urbanised areas in both countries, highlighting the growing significance of financial barriers to family formation in recent years. Furthermore, income has become a stronger predictor of marriage entry by men in both nations. The overall rise in the NVMR reflects delayed marriage among the Chinese population and Korean women, but more persistent singlehood among lower-SES Korean men aged over 35. Notably, the faster growth of the NVMR among lower-SES groups has narrowed overall SES differences in marriage rates, eroding the historical pattern in which lower-SES individuals married earlier and more universally. In other words, marriage differentials based on SES are disappearing on absolute levels. This suggests that while financial constraints remain a key influence, broader structural and cultural shifts ― such as evolving gender norms and rising opportunity costs ― are also critical for understanding recent marriage declines in East Asia.

Population Aging and Living Arrangements: Implications on Inequality / SANG-HYOP LEE, ANDREW MASON, AND HYUN KYUNG KIM

Many previous studies conclude that population aging leads to an increase in consumption or income inequality. The results are based on a conventional model that analyzes compositional effects given interage differences in the means and variances of income. These issues are addressed in this paper by (1) developing a new empirical strategy for estimating the effects of population aging, income, and other socioeconomic variables on living arrangements; (2) extending the standard model of income inequality to incorporate responses in relation to one aspect of the familial support system the formation of multigenerational households (or extended households); and (3) applying the models to South Korea, where familial support has been important source of consumption for older people. In particular, this paper complements previous studies by incorporating the responses of familial support systems to changes in the age distribution of the population. Our model and empirical results suggest that (1) population aging could have led to a greater increase in the proportion living in extended households, but improvements in survival have had a weaker effect than the fertility decline on the proportion of people living in extended households, (2) higher incomes of workers in Korea could have led to more of a shift away from extended households, and (3) an increase in both the proportion of the family cohort and the proportion of pensioners living in extended households reduces the variance in income. These results support the argument that co-residence and population aging may reduce income inequality.

Summary

Monthly Economic Trends KDI Monthly Economic Trends 2026. 3

■	The Korean economy continues to see strong semiconductor momentum and a recovery in consumption, but production growth remains modest amid the downturn in construction.

	○	Export values remain on a favorable trajectory, led by ICT products, but this has yet to translate into higher production volumes.

	-	Despite weakness in other export categories, the sharp rise in semiconductor export values continues to support overall export growth.

	-	Semiconductor prices have surged amid strong demand while supply remains constrained.

	-	By contrast, manufacturing production excluding semiconductors continues to show only modest growth.

	○	Services production shows solid momentum on the back of improving consumption, while weakness in construction investment appears increasingly prolonged.

	-	Consumption continues a gradual recovery, supported by gains in real purchasing power.

	○	Meanwhile, external uncertainty rose as international oil prices surged following the outbreak of the war in the Middle East.

	-	Amid heightened uncertainty regarding the course of the war, sustained high oil prices could place upward pressure on consumer prices.

Summary

Policy Study KOR The Role of Invoicing Currency in International Trade: Determinants and Implications

This study examines the determinants of invoicing currency choice in South Korea’s international trade and analyzes how exchange rates affect trade outcomes across invoicing currencies. Using Korean product-level customs data, it documents distinctive patterns in Korea’s invoicing currency composition and identifies key factors shaping firm-level currency choices for exports.

These factors include the invoicing currency composition of imported intermediate goods, firm-level foreign-currency debt ratios, past invoicing practices, export market share, foreign exchange market size, invoicing currencies of competitors, and exchange rate volatility.

The results show that the degree of exchange rate pass-through varies significantly by invoicing currency, leading to meaningful differences in export volumes. Building on these findings, the study investigates the impact of recent exchange rate movements on Korea’s exports and demonstrates that the dominance of the U.S. dollar as invoicing currency imposes significant constraints on Korean export performance.

This study provides an updated and comprehensive overview of Korea’s invoicing currency patterns in trade, offering rich implications regarding the determinants and consequences of invoicing currency choice. The findings are expected to inform ongoing policy discussions on the revision of the Foreign Exchange Transactions Act, the internationalization of the Korean won, and broader initiatives aimed at advancing Korea’s foreign exchange market.

Summary

Research Monograph KOR Monetary Policy Transmission to the Korean Bond Market

This study quantitatively examines the transmission channels through which domestic and external monetary policy shocks affect the yields of Korean Treasury Bonds (KTBs). To this end, it proposes a new methodology that decomposes long-term KTB yields into expected policy rate paths and term premia and analyzes the interaction between monetary policy and the government bond market through this decomposition. Specifically, the study develops and estimates a four-factor linear term structure model that incorporates gradual structural changes in the level of the KTB yield curve. A comparison with the conventional three-factor model shows that the proposed four-factor model is statistically superior.

The estimation results indicate that, when yields are decomposed into trend and cyclical components, cyclical fluctuations account for a larger share of yield variation at shorter maturities, whereas trend components dominate at longer maturities. The expected policy rate path is extracted from the estimated term premia, suggesting that policy rates are expected to remain broadly stable in the near term and decline gradually thereafter. Analysis of the interaction between monetary policy and the bond market shows that policy rate shocks significantly raise expected policy rates, while shocks to expected policy rates also lead to increases in the actual policy rate. This implies a high degree of mutual credibility between the central bank and the government bond market.

Using this decomposition, the study examines the effects of domestic and U.S. monetary policy shocks on KTB yields. Domestic monetary policy shocks generate significant spillovers across the entire yield curve, from short- to long-term maturities. Short-term yields respond mainly through changes in the expected policy rate path, whereas long-term yields respond more strongly through adjustments in term premia. In contrast, U.S. federal funds rate shocks do not exert statistically significant effects on KTB yields. However, U.S. forward guidance and quantitative easing shocks exert meaningful impacts. Quantitative easing shocks produce larger short-term effects, while forward guidance shocks exhibit greater persistence. Nevertheless, these spillovers are considerably shorter-lived than those from domestic monetary policy shocks, highlighting the relative independence of Korea’s monetary policy.

The study also analyzes the Korean corporate bond market in the context of domestic and external monetary policy. Although the corporate bond market has expanded steadily in terms of outstanding issuance, secondary market liquidity remains limited, with turnover ratios substantially lower than those in the government bond market and trading concentrated in financial bonds. U.S. monetary tightening is found to reduce corporate bond trading volumes and widen credit spreads, with a 25 bp increase in the U.S. policy rate leading to an immediate spread widening of 11―13 bp. Over a horizon of one to three months, corporate bond spreads increase by 28―56 bp. Domestic monetary policy shocks also have significant effects on corporate bond yields, with particularly pronounced responses in lower-rated (BBB-) bonds. By contrast, firm-level financial conditions do not appear to systematically influence the sensitivity of corporate bond yields to U.S. monetary policy shocks, likely reflecting a flight-to-quality behavior during tightening episodes.

Summary

Monthly Economic Trends KDI Monthly Economic Trends 2026. 2

■	The Korean economy continues to register a moderate expansion in overall output, led by the service sector amid a gradual improvement in consumption conditions.

	○	Investment remains subdued, but exports―led by semiconductors―continue on a modest upward path, alongside a gradual recovery in consumption.

	-	The value of construction completed remains subdued, as activity continues to be weighed down by weakness in regional real estate markets, despite some easing in the pace of decline; equipment investment also continues to contract.

	-	Export volumes increase at a more moderate pace, while export values rise sharply, reflecting a surge in semiconductor prices.

	-	Consumption continues to recover from earlier weakness, supported by rising household income and the cumulative impact of interest rate cuts, with consumer sentiment staying elevated.

	○	On the production side, the continued recovery in the service sector supports a moderate increase in all-industry production.

	-	Improvements in consumption translate into relatively solid growth across most service industries.

	-	Manufacturing production declined slightly, as automobile output weakened following U.S. tariff measures, while semiconductor production remained somewhat constrained by supply limitations despite a surge in demand.

	○	At the same time, external uncertainty intensifies somewhat, reflecting the risk of additional U.S. tariff hikes and increased volatility in oil prices.

Summary

Monthly Economic Trends KDI Monthly Economic Trends 2026. 1

■	Overall production in the Korean economy continues to expand at a modest pace, underpinned by improving consumption, even as weakness in construction persists and manufacturing undergoes some adjustment.

	○	Construction activity remains in sharp contraction and continues to act as a primary constraint on the pace of economic recovery.

	○	Semiconductor-related export values maintain strong growth amid favorable market conditions; however, this performance largely reflects sharp price increases, while previously elevated production growth has moderated.

	-	Meanwhile, as production outside the semiconductor sector sustains only modest growth, manufacturing business sentiment remains at low levels.

	○	However, consumption continues to improve, with retail sales maintaining modest growth and services production showing signs of recovery.

	-	The Composite Consumer Sentiment Index (CCSI) remains at a relatively elevated level, while business sentiment in non-manufacturing sectors continues to improve.

	-	Despite ongoing weakness in construction and manufacturing, growth in the number of employed persons has edged up slightly, led by services.

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