Effects of Monetary Policy Shocks on the Exchange Rate in the Republic of Korea: Capital Flows in Stock and Bond Markets

Soyoung Kim

Asian Development Review, 2014, vol. 31, issue 1, 121-135

Abstract: Several studies have suggested that the prediction of standard theory on the effects of monetary policy on the exchange rate might not be applicable to or in the case of the Republic of Korea because participation of foreign investors is weak in the bond market but strong in the stock market. The current study examines the effects of monetary policy shocks on the exchange rate in the Republic of Korea by using structural vector autoregression models with sign restrictions. To determine the channels by which monetary policy shocks affect the exchange rate, I investigate the effects on various components of capital flows. The main empirical findings are as follows. First, a contractionary monetary policy shock, which increases the interest rate, appreciates the Korean won significantly in the short run as predicted by most theories. Second, contractionary monetary policy shocks increase capital inflows into the bond market consistent with the prediction of the uncovered interest parity condition. This seems to be the main channel by which contractionary monetary shocks appreciate the won. Finally, foreign investors tend to withdraw money from the domestic stock market in response to a monetary tightening, resulting in a decrease in capital inflows. © 2014 Asian Development Bank and Asian Development Bank Institute.

Keywords: monetary policy shocks; vector autoregression; sign restrictions; exchange rate; capital flows (search for similar items in EconPapers)
JEL-codes: F31 F32 F33 F36 (search for similar items in EconPapers)
Date: 2014
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (6)

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