The Relationship of Economic Fundamentals and Real Exchange Rate between Korea and China

This paper examines the real exchange rate’s(REER) response to the real GDP, FDI, M2, trade openness(OPEM), foreign reserves (FER)and government expenditure(GE) for Korea and China. The analyses are based on the VECM and NATREX models. In short run for China, we find that RGDP, FER and GE have positive impacts on REER; M2 has negative impact on REER; REER has positive impact on RGDP. For Korea, we find that OPEN and GE have positive impacts on REER; RGDP and M2 have negative impacts on REER. REER does not have significant impact on RGDP. In long run for China, we find RGDP, FER and GE have positive impacts on REER; OPEN and M2 have negative impacts on REER. For Korea, we find that OPEN, FER and GE have positive impacts on REER; RGDP and M2 have negative impacts on REER. The results of Half-life show that the speed of equilibrium movement of Korean real exchange rate is faster by comparing with the Chinese real exchange rate, And comparing with Chinese RGDP, the speed of equilibrium movement of Korean RGDP is slower. With the implementation of one belt and road initiative, we think that the exchange rate regime of China may be transferred to the flexible exchange rate like Korea.