ESRI Working Paper Series No.1

Capital Inflows, The Stock Market and Macroeconomic Policy
in Emerging Market Economies: The Experience of Korea

July, 2001
Jai-Won Ryou
(Konkuk University and Yale University)
( full text )
(Abstract)

    This paper explores the role of capital inflows through the stock market into emerging market economies. For a small open economy in which equity investment is more crucial than debt investment, the relative effectiveness of monetary policy over fiscal policy does not hold. The expansionary monetary policy decreases domestic interest rates but increases the expected rate of return on equity investment. The subsequent capital inflows appreciate the domestic currency, and the net effect on output is indeterminate. The desirability of the flexible exchange rate as a shock absorber is also confirmed. Empirical evidence from the Korean economy after the currency crisis supports these findings.

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Abstract
Contents
I. Introduction------------------------------------------------------------------- 1
II. Capital Inflows into Emerging Market Economies----------------------------- 4
 1. Recent Trends in Capital Inflows into Emerging Market Economies----------- 4
 2. Portfolio Investment in Korea ------------------------------------------------ 8
III. A Small Open Economy Model--------------------------------------------- 12
 1. The Goods Markets--------------------------------------------------------- 12
 2. The Financial Markets------------------------------------------------------- 12
 3. The Balance of Payments---------------------------------------------------- 17
 4. The Equilibrium of the Economy -------------------------------------------- 19
IV. Macroeconomic Policy and External Shocks-------------------------------- 20
 1. The Monetary Policy-------------------------------------------------------- 20
 2. The Fiscal policy ----------------------------------------------------------- 22
 3. Increase in World Interest Rates-------------------------------------------- 24
V. Empirical Analysis----------------------------------------------------------- 27
 1. Data and Methodology------------------------------------------------------ 27
 2. Money Supply Shock------------------------------------------------------- 28
VI. Conclusion----------------------------------------------------------------- 31
References--------------------------------------------------------------------- 34
Appendix---------------------------------------------------------------------- 37