the economic growth of korea after 1990 identifying contributing factors from demand and supply sides

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,…

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International Financial market and Korean Economy

This material is based on Chapter 5 of <The Rise of China and Structural Changes inKorea and Asia> edited by Takatoshi Ito and Chin Hee Hahn (Edward Elgar (2010)

Class Note 10

The Economic Growth of Korea after 1990:

Identifying Contributing Factors from Demand

and Supply Sides

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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,…

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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 run restrictions and (2) Estimate SVAR models with them.

long- Shocks are roughly classified into demand, supply and foreign shocks.

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

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Real GDP Growth

Institutional Changes after the Currency Crisis

• Restructuring in Financial Sectors

• Inflation Targeting

• A Floating Exchange Rate System

-40 -35 -30 -25 -20 -15 -10 -5 0 5 10 15 20 25 30 35

1971 1974 1977 1980 1983 1986 1989 1992 1995 1998 2001 2004 2007

lrGDP lrGDP(s.a)

(Year-on-Year % Change, Yearly Growth Rate, %)

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Shim(2001)

•Assuming a closed economy

•Shocks are arranged so as to have a lower triangular covariance matrix.

•Not based on economic models

•Doesn’t consider the institutional changes after the Crisis.

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 Demand Shocks

•(Domestic) Idiosyncrasies in Consumption,

Investment, Fiscal Stance and FX Market

•(Foreign) TOT , the world economic growth

•Supply Shocks

•(Domestic) Changes Factor Productivities and TFP

•(Foreign) Changes in the Prices of Raw Materials including Oil and Technological Progress

Sources of Shocks and Transmission Channels(1/2)

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 Changes of the Economic Environments

•(Domestic) Restructured financial market, inflation targeting, and flexible exchange rate

•(Foreign) Global phenomena of low interest rate and housing price hike, and the emergence of China as a world economic power

Sources of Shocks and Transmission Channels(2/2)

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 Backbone

•Blanchard and Quah(1989)

•Stock and Watson(2002)

•With an additional assumption of “A small open economy”.

Estimated Equations and Identifications(1/8)

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A Inflation Targeting and Flexible Exchange Rate

• Modified from Stock and Watson(2002)

• A monetary authority follows a Taylor rule.

• A small open economy: TOT and Exchange rate

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(1) IS curve

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

(3) Forward looking Taylor rule

(4) An equilibrium condition of the FX market

) (

, ] [

1

, ,

1

f t t t

t k

j

j t t t

t

y t

y t t t t

p e p

q

E k

R r

q r y

ε θ

θ θ

κ

π

ε δ

γ

i

i t

p i t t

i

] [

p i t t y

h t t

r

1

] [

]

βπ

] [ t 1 t

t

f t

R = + + −

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(5) Derive a SVMAR system, which represents macro

variables ( ) as functions of exogenous shocks ( )t t t t

e R

e t t

y t

p

ε ε

0 0 0 1

1 0 0 1

0 0 0

1 )

(

j

f t

e j t

j t

y j t

j f

t

f t

e t t

y t

t t t t

R e

e e

e

A R

e e e

e L A e

R

π π

π

π π

0

0 0

0 )

NA NA

NA

NA NA

A A

A

j j

• Productivity shock( )

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

• Demand shock( ), Price Shock( )

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

• Exchange rate shock( )

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

p

y t

ε

y t

ε

e t

ε

π

εtEstimated Equations and Identifications(4/8)

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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.

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(1) Aggregate demand curve (a combination of IS and LM)

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

(3) An equilibrium condition of the FX market

(4) Money supply

π

ε δ

γ

i

i t

p i t t

i

= 0 + +

] [

f t R f

f t t

f t

R = , = , = ,

y t

IS t y

t

y t

k j

t j t t t

t t

b

a b

a

q E

k p

m b

π κ

κ

+

=+

≡

++

1

,)

1(

][)

(

t

f t t

m = + +

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(5 ) Derive a SVMAR system, which represents macro variables ( ) as functions of

exogenous shocks ( ) ε ε επ ε , ε , π

, ,

, , t y t t f x t f

y t

p

f t t t

NA NA NA

NA NA

NA NA NA

NA NA NA NA NA

A A

A

j j

000

00

0

00)

) (

j

f j t

x f j t

j t

y j t

y j t j

f t

x f t t

y t

f t t t t t

e e e e e A

e e e e e

L A m

R

π

π π

π

π π

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(6) Rearrange with three variables

• To handle with over-identification, run the log-likelihood -test additionally

∆

+ +

0 0

) (

0

υ υ

υ π κ

π

κ π

π π

f t j

j t

y j t

y j t j f

t

f t

j

j t

y j t

y j t j t

t t

e e

e A R

b

R

e e

e A m

0 0

NA

NA NA

NA A

ε

π

εt

y t

ε

2χ Estimated Equations and Identifications(8/8)

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 Time Coverage and Notable Features

• Source : BOK

• Real GDP, Price, Exchange Rate (US $/KOR W) , Money :

1970.1/4~2007.2/4

• The yield of 1 year Government Bond : 2000.1/4~2007.2/4

• 3 month CD (91 days) Rate: 1991.1/4~2007.2/4

• Has a longer series than that of 1 year Government Bond but is not a proper representative interest rate.

• Call rate ( a cousin of FFR in Korea) is not used for the

frequency mismatch.

• M2 for the Monetary Aggregate

The Descriptions of the Data (1/3)

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 Unit Root Test Results(DF-GLS)

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

Test statistic

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 Lag Order Selection Criteria for S-W Model

2000.1/4

~2007.2/4

Growth rate of real GDP

InflationInterest rate(3-month TB) Unemployment rateChange rate of exchange rate

aggregate

The Descriptions of the Data (3/3)

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 The estimation results are displayed:

IR and FEVD Analysis (1/14)

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• 2000.1/4~2007.2/4

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

IR Analysis (2/14)

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• 2000.1/4~2007.2/4

Growth rate of real GDP Inflation

Interest Rate Volatility of the exchange rate

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

shock 1 shock 2 shock 3 shock 4 shock 1 shock 2 shock 3 shock 4

FEVD Analysis (3/14)

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(1991.1/4~1997.3/4)

<FEVD> Changes in Changes in Changes in

growth rate of real GDP interest rate monetary aggregate

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

shock 1 shock 2 shock 3 shock 1 shock 2 shock 3 shock 1 shock 2 shock 3

IR and FEVD Analysis (4/14)

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

C B-Q(1989)’s Original Model (2-variables and 2-shocks)

(1970.1/4~2007.2/4)

shock 1 shock 2 shock 1 shock 2

IR and FEVD Analysis(5/14)

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

(1970.1/4~1979.4/4)

shock 1 shock 2 shock 1 shock 2 shock 1 shock 2 shock 1 shock 2

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(1980.1/4~1989.4/4)

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(1990.1/4~1999.4/4)

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<Impulse Response> Growth rate of real GDP Unemployment rate

(2000.1/4~2007.2/4)

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D An Extension of B-Q(1989)(3 variables and 3 shocks)

(1970.1/4~2007.2/4)

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

Growth Rate of Real GDP Inflation Unemployment Rate

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(1970.1/4~1979.4/4)

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(1980.1/4~1989.4/4)

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(1990.1/4~1999.4/4)

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(2000.1/4~2007.2/4)

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 Our models are special in that (1) they extend the

closed economy of the original S-W(2002) to a small open economy and (2) they contrast the institutional changes in Korea after the Financial Crisis.

Concluding Remarks(1/2)

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 On the other hand, the market friendly institutional changes( the introductions of the inflation targeting and the flexible exchange rate system) may absorb shocks more effectively.

 Overall, the magnitudes and the persistence of impulse responses tend to decrease in 2000s.

 In addition, successfully coordinated low interest rate regime

initiated by FRB in the early 2000s contributes to reducing shocks themselves.

Concluding Remarks(2/2)

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