The real impact of financial shocks: evidence from the Republic of Korea

Ilker Domac and Giovanni Ferri

No 2010, Policy Research Working Paper Series from The World Bank

Abstract: The debates surrounding the recent East Asian crisis have focused not only on causes but also on policy actions in the wake of the initial shock. This has raised questions about the relationship between monetary policy and market confidence. Specifically, would rising interest rates bolster or depress market confidence? To answer this question requires assessing whether, and to what extent, monetary and financial shocks are magnified through the economy via the credit channel. The authors focus on the Republic of Korea - a particularly good case for testing credit channel effects - with two objectives: a) To ascertain whether and to what extent interest rate spreads could help predict subsequent fluctuations in real economic activity. b) To test whether small and medium-size enterprises suffer more than other business do from the adverse effects of the credit channel. The author's empirical findings support the hypothesis that spreads that capture credit channel effects do indeed influence economic activity. Specifically, spreads contain significant information for predicting the future course of industrial production. The effect is, as one might have assumed, disproportionately larger for small and medium-size enterprises. Thus policymakers, in Korea and elsewhere, who neglect credit channel effects might be"overkilling the economy"and altogether overlooking the disproportionate effects of monetary and financial shocks on various segments of the economy.

Keywords: Economic Theory&Research; Financial Intermediation; Environmental Economics&Policies; Payment Systems&Infrastructure; International Terrorism&Counterterrorism; Environmental Economics&Policies; Banks&Banking Reform; Financial Intermediation; Financial Crisis Management&Restructuring; Economic Theory&Research (search for similar items in EconPapers)
Date: 1998-11-30
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Citations: View citations in EconPapers (19)

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