The Effects of Globalization on Macroeconomic Dynamics in a Trade-Dependent Economy: The Case of Korea

Abstract

This paper studies the implications of globalization for the dynamics of macroeconomic variables over the business cycle for a small open trade-dependent economy, such as Korea.

We study the impact of globalization through the lens of a structural model. Globalization is modeled as a time-varying degree of openness in the economy. We estimate the model allowing for non-fully rational expectations, learning by economic agents, and incomplete international financial markets.

The empirical results show that globalization led to important changes in the macroeconomic environment. Domestic variables have become much more sensitive toward global measures over the 1991-2012 sample. In particular, domestic output and inflation are significantly affected by global output. Fluctuations in Korean output, inflation, and interest rates, which were driven for the most part by domestic shocks in the early 1990s, are due in large part (roughly 70%) to global shocks (and shocks inherent to an open-economy) by the end of the sample.

Keywords: Globalization, Inflation Dynamics, Global Slack Hypothesis, Openness, Inflation Expectations, Small Open Economy DSGE Model, Korea

JEL Classification: E31, E32, E50, E52, E58, F41, F62