International Financial market and Korean Economy

Class Note 10
The Economic Growth of Korea after 1990:
Identifying Contributing Factors from Demand
and Supply Sides
This material is based on Chapter 5 of edited by Takatoshi Ito and Chin Hee Hahn (Edward Elgar (2010).


Introduction(1/2)
The Purpose of This Study is
 To understand the Growth of Korean Economy since
1990
• Based on two linear stochastic models, which
contrast the institutional changes Korea went
through after the Financial Crisis
• To measure the relative contributions of various
shocks to the growth path of Korea
• Demand, supply (productivity), oil shocks,…


Introduction(2/2)
Methodology
 Introduce two systems of linear stochastic difference
equations, each of which represents the Korean
economy before and after the Financial Crisis.
 Following Blanchard and Quah(1989), (1) Derive longrun restrictions and (2) Estimate SVAR models with
them.
 Shocks are roughly classified into demand, supply and
foreign shocks.

3.4

3.8

4.8

2.1

3.9

• Speed

of Growth is decelerating.

“ Is it a ominous sign of Slowdown? Or Are we there
yet?”


Observations(2/2)
Real GDP Growth
(Year-on-Year % Change, Yearly Growth Rate, %)

35
30
25
20
15
10
5
0

• Inflation Targeting
• A Floating Exchange Rate System

1998

2001

lrGDP(s.a)

2004

2007


Discussions
Shim(2001)
•Assuming a closed economy
•Shocks are arranged so as to have a lower triangular covariance
matrix.
Kim(2005)
•Analyzing the impact of foreign shocks on domestic economy.
Oh(2007)
•An open economy version of B-Q(1989), consisting of Import
Volume, GDP and CPI.
Limitations
•Not based on economic models
•Doesn’t consider the institutional changes after the Crisis.


Sources of Shocks and Transmission Channels(1/2)

• A monetary authority follows a Taylor rule.
• A small open economy: TOT and Exchange rate


Estimated Equations and Identifications(3/8)
A. Inflation Targeting and Flexible Exchange Rate
(1) IS curve
yt = κrt − qt + θ ty , θ ty = θ ty−1 + ε ty ,
1 k
rt = Rt − ∑ Et [π t + j ] , qt = pt − (et + ptf )
k j =1

(2) New Keynesian Phillips curve (Aggregate supply curve)
∞

π t = γ ∑ δ i Et [ ytp+i − yt +i ] + ε tπ
i =0

(3) Forward looking Taylorh rule
rt = β π Et [π t + h ] + β y ∑ Et [ y tp+i − y t +i ]
j =1

(4) An equilibrium condition of the FX market
Rt = Rt f + Et [et +1 − et ]


Estimated Equations and Identifications(4/8)
(5) Derive

a SVMAR system, which represents macro


0  π t f
 f

0  Rt

− 1

 ety− j   1

 
y
∞
e  0

 = ∑ A j  tπ− j  + 

 j = 0  et − j   0
 e e   0
 t− j 
p

− 1

0  π t f
 f

0  Rt

− 1


-(P) real GDP, (T) price, interest and exchange rate


Estimated Equations and Identifications(5/8)
B. Aggregate Targeting and Fixed Exchange Rate
• The monetary authority controls the Quantity of
Money
• By adjusting Money Growth
• Assuming a fixed or managed exchange rate system,
• Autonomy of monetary policy is tied to maintain
0 interest rate differential with a foreign country.
• The model describes Korea before the financial crisis.


Estimated Equations and Identifications(6/8)
B. Aggregate Targeting and Fixed Exchange Rate
(1) Aggregate demand curve (a combination of IS and LM)
κ
yt =

b

( mt − p t ) −

κ
k

(1 +


∞

π t = γ ∑ δ i Et [ ytp+i − yt +i ] + ε tπ
i =0

(3) An equilibrium condition of the FX market
Rt = Rt f , et = e , Rt f = S f , R X t f

(4) Money supply
mt = yt + bRt f + pt


Estimated Equations and Identifications(7/8)
(5)

Derive a SVMAR system, which represents macro
variables ( ∆yt , π t , Rt , ∆mt , π t f ) as functions of
exogenous shocks (ε ty , ε ty , ε tπ , ε t f , x , ε t f ,π )
p

p
 ety− j 
 ety 
 ∆yt 









∞
A∞ ≡ A(1) = ∑ A j =  0
0 NA NA 0 


j =0
NA
NA
NA
0
0


 0
0
0 NA NA 


• Singularity arises in the longrun response matrix of A∞ .
• Decrease the numbers of shocks
and variables.


Estimated Equations and Identifications(8/8)
(6) Rearrange with three variables
2
• To handle with over-identification, run the log-likelihood χ-test
additionally


 
p

• Productivity shock(ε ty )
p

 NA NA NA 


A∞ =  0
0 NA 
 0 NA 0 



-(P) real GDP, (T) interest rate and money
• Demand shock( ε ty )
- (P) real GDP and Money, (T) interest rate
π

• Price shock(ε t )
- (P) real GDP, (T) interest rate and money


The Descriptions of the Data (1/3)
 Time Coverage and Notable Features
• Source : BOK
• Real GDP, Price, Exchange Rate (US $/KOR W) , Money :
1970.1/4~2007.2/4

-1.615

Inflation(GDP deflator)

-2.712

-2.581

-1.943

-1.615

Nominal interest rate
(TB 1-year)

-1.365
(-4.395)

-2.647
(-2.650)

-1.953
(-1.953)

-1.610
(-1.610)

Nominal interest rate
(CD 91 days)


(-2.581)

-1.943
(-1.943)

-1.615
(-1.615)

Unemployment rate

2.659

-2.581

-1.943

-1.615

Note: ( ) is a result of the first order difference.


The Descriptions of the Data (3/3)


Lag Order Selection Criteria for S-W Model
Periods

Variables

LR


Growth rate of real GDP
Inflation
Interest rate(3-month CD)
Growth rate of monetary
aggregate

2

1

19

19

19


IR and FEVD Analysis (1/14)
 The estimation results are displayed:
 Impulse Response analysis
 Forecasting Error Variance Decomposition


IR Analysis (2/14)
A. Inflation Targeting and Flexible Exchange Rate
• 2000.1/4~2007.2/4
Real GDP

Price index


shock 1

shock 2

shock 3

shock 4

Volatility of the exchange rate

shock 4

shock 1

shock 2

shock 3

shock 4

Note: Each of shock 1,2,3,4 represents a shock from productivity, or aggregate demand, or price, or exchange rate.


IR and FEVD Analysis (4/14)
B. Aggregate Targeting and Fixed Exchange Rate
(1991.1/4~1997.3/4)
<Impulse Response>

<FEVD>

shock 2

Note: Each of shock 1,2,3 represents a shock from productivity, or aggregate demand, or price.

shock 3


IR and FEVD Analysis(5/14)
C. B-Q(1989)’s Original Model (2-variables and 2-shocks)

(1970.1/4~2007.2/4)
<Impulse Response> Growth rate of real GDP

<FEVD>

Changes in growth rate of real GDP

shock 1

shock 2

Unemployment rate

Changes in unemployment rate

shock 1

shock 2

Note: Each of shock 1,2 represents a shock from demand side or supply side.