The Dynamic Patterns of Foreign Influences on the Korean Economy

The purpose of this paper is to assess the dynamic patterns of foreign influences on the Korean economy. In particular, this paper aims to assess the relative impact of the U.S. and Japanese business cycles on the Korean economy. Our vector autoregression (VAR) models include the real GDPs of Korea, the U.S. and Japan, and world oil price, which are quarterly covering the period from 1970:1-2003:4. To take account of possible structural changes due to adoption of a new exchange rate system and rapid opening of trade and financial markets in the 1990s, estimates are also made separately for the period 1970:1-1989:4 and compared to those obtained from the full sample. Using the recursive regression technique, this paper also traces the changing patterns and extents of foreign influences on the Korean economy. Based on the findings from the recursive regression, the full sample period is re-estimated with a deterministic dummy for the period of 1997:3-1998:4 to accommodate for the effects of the 1997-98 financial crisis. We find that the U.S. business cycle has a larger impact on movements in Korean GDP than the Japanese business cycle does. We also find that despite the trade and financial market liberalization in the 1990s, the adoption of the floating exchange rate may have increased the degree to which the Korean economy is insulated from foreign disturbances. But this may be in large part associated with a reduction in the magnitude of the common international shock - the world oil price.