Exchange Market Pressure in Korean: An Application of the Girton-Roper Monetary Model: Note

Abstract

Korea's exchange rates have been changing daily since its adoption of the flexible exchange rate system in February 1980. The purpose of this paper is to examine the simultaneous adjustment of both exchange rates and the balance of payments in Korea. The Girton-Roper (1977) model of exchange market pressure is applied. The model draws on a combination of the monetary approach to the balance of payments (Johnson 1972) and to exchange rate determination (Frenkel and Johnson 1978). The main theoretical proposition of the Girton-Roper (hereafter, G-R) model states that an excess domestic supply of money will cause some combination of currency depreciation and an outflow of foreign reserves. The G-R model of exchange market pressure was designed for the Canadian managed float during the period from 1952 to 1962. Connolly and Silveira (1979) took the G-R model and applied it to the Brazilian experience for the period from 1955 to 1975. Modeste (1981) used the same model to explain the monetary experience of Argentina in the 1970s. Korean experience provides another good opportunity to test theoretical propositions of the G-R version of the monetary approach to managed floating. First of all, Korea fits the model of exchange market pressure because the country can be treated as a small open economy which takes foreign prices as given. In addition, changes in Korea's exchange rates can be considered to be the product of market pressure since the Korean won is linked to a multicurrency basket. The exchange rate of the Korean won is determined largely by the exchange rate formula which relies on both the special drawing right (SDR) basket and Korea's own currency basket. It is according to this formula that the Bank of Korea establishes daily the exchange rate in terms of the intervention currency, the U.S. dollar.l