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Integration with the Global Economy: A Structural Macroeconometric Modelling of Korea

This study analyzes Korea's remarkable economic transformation, also known as the Korean Miracle, from the 1960s to 2003, highlighting key achievements like a 6000-fold increase in exports and rapid industrialization. It discusses challenges like oil price shocks and the Asian financial crisis, employing an IS-LM-BP-PPP framework for econometric modeling. The paper also identifies key trading partners and assesses the effectiveness of monetary policy, concluding that domestic factors must be prioritized over exchange rate stabilization for sustainable growth.

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Integration with the Global Economy: A Structural Macroeconometric Modelling of Korea

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  1. Integration with the Global Economy: A Structural Macroeconometric Modelling of Korea Jarir Ajluni

  2. Background

  3. Background: The Korean Miracle Key Achievements of the Korean Economy • Growth. (GDP per capita doubled 11 times during 1960 – 2003) • Exporting Boom. (Gross exports increased by 6000 times!) • Industrialisation (increased share of manufactured exports) • Financial Development (financial Depth in M2/GDP). • Attractive destination for FDI. • Joining the OECD!

  4. Background: The Korean Miracle Key Challenges to the Korean Economy • Oil Price Hikes (OPEC oil price shocks 1973 & 1979) • Integration (increased exposure to global fluctuations) • Geo-Political Constraints. • Corruption. • The Asian Crisis of 1997(currency crisis, increased interest rates, doubled Unemployment, recession)

  5. Modelling Strategy

  6. R, ex IS y LM LM BP IS BP The Theoretical Framework • The IS-LM-BP Framework • Purchasing Power Parity PPP

  7. Core Model Econometric Formulation of IS-LM-BP-PPP leads to: Error terms above are “Deviations from Equilibrium”

  8. Classifying trading partners Trading partners are grouped into: • United States (US). • Rest of the G7 (RG7). • Rest of the OECD countries (ROECD). • Developing Oil Exporting Countries (DOEC).(including OPEC & non-OPEC exporters) • Rest of Developing Trading Partners (RDTP).

  9. Construction of the Trade Weights Country Trade Weights (h: home f: foreign economy) Regional Trade Weights (h: home j: Region) Aggregation conditions holds:

  10. Directions of Trade 1980 - 2000 36% of trade towards Developing countries 45 % of trade towards Developing countries Importance of the G7 group: US and Japan

  11. Construction of the Model Global vector by using trade weights of (6.1) (6.2) VAR in (8) would be written in the form of (9)

  12. Let vector Z be: Weak Exogeneity imply: VECM & Partial Systems Then the VECM of (9) would be : then we could split (10) into:

  13. Recall VECM: Identification applying restrictions from (5a – 5d) derived from IS-LM-BP-PPP.

  14. Empirical Results

  15. Empirical Results • Presence of 4 Cointegration relationships. • Identification restrictions rejected. • Weak Exogeneity of Global Vector & Oil Price. • Low Capacity for an Independent Monetary Policy. • Evidence on higher interest rates strangling the economy (Stiglitz was right!).

  16. Impulse Response Functions Response to domestic monetary policy shock

  17. Response to foreign monetary policy shock

  18. Response to foreign monetary policy shock

  19. Emphasise the relative responsiveness

  20. Policy Implications • Raising the Interest Rate is NOT effective in generating capital inflow supporting the exchange rate, other factors should be considered. • High responsiveness of the Interest Rate suggest Monetary policy would not be independent and should target domestic financial system & inflation NOT the exchange rate. • The importance of adjusting to foreign monetary policy shocks: The Best Response proposition.

  21. Testing the Model’s forecasting validity Root Mean Square Errors: y : 0.33429 p : 0.278432 m-p: 0.65651 R :26.25877 e : 0.960

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