International Linkages of the Korean Economy: The Global Vector Error-Correcting Macroeconometric Modelling Approach

Abstract

This paper analyses the international linkages of the Korean economy using the GVAR model developed by Greenwood-Nimmo, Nguyen and Shin (2012a, J. Appl. Econometrics). By employing a combination of generalised impulse response analysis and forecast error variance decompositions, we uncover a number of interesting phenomena. Among our most important results are the findings that the real economy and the financial markets are highly sensitive to the oil price even though it has little effect on inflation and that the interest rate is set largely without recourse to overseas conditions except to the extent that they are captured by the exchange rate. We find that the dominant sources of overseas influence on the Korean economy are the US, the Eurozone, Japan and China. Korea’s complex and open linkages with these countries will inevitably pose challenges for domestic economic management and stabilisation policy faced by the Korean monetary and fiscal authorities.

Keywords: Global VAR, impulse response analysis, forecast error variance decomposition

JEL Classification: C32, C53, E17