Abstract
The aim of this study is to investigate effects of changes in government expenditure on real exchange rate for Korea during the period of 1998. I - 2016. IV. We use Error Correction model based on Pesaran, Shin and Smith (2001)’s ARDL bounds test to estimate long run and short run relationship between changes in government expenditure and real exchange rate. The results show that changes in government expenditure during the period had a significant positive effect on real exchange rate in Korea. The long run response of real exchange rate was more than twice larger than the short run response. To be more specific, one percent increase of the ratio of government expenditure to GDP raised the real exchange rate by 0.99% in the short run while the same change raised the real exchange rate by more than 2.55% over the long run. The positive empirical effect of government expenditure increase on the real exchange rate found by the present study is broadly in line with many other previous studies. Theoretically, this result is in line with the assertion that an expansionary government expenditure would raise relative price of non-tradable goods when the government expenditure has a home bias and so a positive effect on the real exchange rate.
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