Three Essays on International Linkages of the Korean Economy.

Abstract

This dissertation consists of three essays. The first essay investigates whether the long run version of purchasing power parity (PPP) holds between Korea and its two major trading partners--the U.S. and Japan. The PPP relationship is examined using cointegration tests, which are proper to see the departures from the long run equilibrium. The second essay examines the empirical relationship between real exchange rates and interest rate differentials in the Korean-U.S. as well as the Korean-Japanese economies. This relationship is also examined using cointegration tests. The third essay examines how foreign economic shocks affect the Korean economy and analyzes the channels through which they are transmitted. Also, the relative importance of domestic and foreign shocks on the dynamics of certain key macro variables is investigated. The techniques of vector autoregression (VAR) are employed to investigate the international transmission of economic disturbances. Each VAR system (that is, Korea-U.S. system and Korea-Japan system) contains variables for Korea and the U.S. or Korea and Japan, and uses monthly data from May 1973 to June 1990. The dynamic effects of foreign shocks on the Korean economy are evaluated by estimating variance decompositions (VDCs) and impulse response functions (IRFs). The following three results emerge from the empirical findings of this dissertation. First, no evidence of cointegration is found for any pair of prices and exchange rates between Korean and U.S. as well as Korean and Japanese economies. We might say that monetary models of exchange rate determination understate the role of real disturbances in the world economy. Second, the empirical findings about the relationship between real exchange rates and real interest rate differentials do not support the hypothesis of cointegration between these variables. This suggests that a variable (possibly the expected value of future real exchange rate) is omitted from the real exchange rate-interest rate differential relation. Third, empirical findings regarding the international transmission mechanism indicate that foreign shocks are important for the Korean economy during the sample period, though the channels of transmission differ.