Capital Liberalization, Capital Flows, and Monetary Policy Responses on Exchange Market: The Case of Korea

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University of Missouri-Columbia, 2001 - Capital movements - 242 pages
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This paper examines some of the most vital aspects of Korea's experience with capital flows, such as the determinants of capital flows, the monetary policy on exchange market, and the relationships among capital liberalization, capital flows, domestic credit, and exchange market. I construct indexes of capital liberalization on controls of capital inflows and outflows based on documented policy changes made by the Koran government. I use EMP (Exchange Market Pressure) as well as nominal and real exchange rate as terms of exchange market. The main findings of this paper are as follows. (1) Interest rate differentials as a variable of portfolio theory do not explain capital flows in Korea. The interest rate differential terms are often of the wrong sign, so Korea's capital flows are not explained by the portfolio theory. On the other hand, the changes of domestic credit are generally significant in capital flow. This result suggests that the monetary approach may be good in explaining capital flows. (2) Using VAR framework, I find that the change of domestic credit is a good stance of the monetary policy, and the negative shock to the change of domestic credit affect the appreciation of nominal and real exchange rate. A contractionary monetary policy leads to continuous appreciation and leads to reduce exchange market pressure. (3) I cannot reject the null hypothesis that CLI is not Granger-caused by any variables. The capital liberalizations in Korea are exogeneous. (4) I find that capital inflows increase persistently after shocks to liberalization policy while capital outflows increase temporally. I also find that shocks to liberalization of capital outflows attract capital inflows. (5) Domestic credit responds negatively on capital inflows and positively on capital outflows. The sterilization was effective for one month after capital inflows. (6) The responses of nominal and real exchange rates to capital inflows are negative and exchange rates are appreciated as in theory and empirical tests.

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