Economic shocks, current account and macroeconomic adjustment : theory and practice in Korea

Abstract

The main purpose of this thesis is to identify the dynamic effects of exogenous economic shocks on the macroeconomic adjustment in a small open resource-poor economy, Korea. It is well known that the macroeconomic adjustment process of an open economy is best analyzed within an intertemporal general equilibrium framework. However, empirical application of the framework has been very limited despite its theoretical elaborateness. This thesis provides one of the possible solutions to the apparent problem discussed above. To analyze the effects of exogenous economic shocks on macroeconomic adjustment, an intertemporal general equilibrium model is developed, and the effects of an imported intermediate input price shock as well as various government policy shocks are analyzed. By introducing a risk premium to the real interest rate and imported intermediate input in production process, quite realistic theoretical predictions are obtained about macroeconomic adjustment process. The basic framework is, then, extended to be applied empirically. At this stage, the role of government is explicitly introduced as a Stackelberg leader against the producer and the consumer. The information structure among the players are assumed to be open-loop. The resulting behavioral decision functions for the three players are econometrically estimated with the assumption of rational expectations. The estimation results of the forward-looking behavioral equations are quite satisfactory. Additionally, simulation analysis is carried out to identify the quantitative effects of each individual exogenous economic shock. The simulation results are, by and large, consistent with the qualitative results. The main advantage of the simulation analysis was its ability to decompose separate macroeconomic effects according to their causes and origins. The analysis provides a clear picture of how the macroeconomy operates in response to exogenous economic shocks. Among exogenous shocks, the price of imported intermediate input, the world real interest rate and the real wage are shown to have a crucial importance in macroeconomic adjustment process in Korea