Impact of currency depreciation on real GDP in South Korea. (Anthology).

During the Asian financial crisis a few years ago, many countries experienced currency depreciation, capital outflows, declining output, high unemployment, and bankruptcies of firms, among others. South Korea encountered a similar economic bust. In order to stimulate the economy, dramatic currency

The impact of currency depreciation on real GDP may be uncertain. The depreciation of a currency stimulates exports, shifts the aggregate demand curve to the right, and increases real GDP. On the other hand, a currency depreciation makes imported goods and services more expensive, causes input prices to rise, shifts the aggregate supply curve to the left, and reduces real GDP. Therefore, the net effect depends on the relative shifts of the aggregate demand and aggregate supply curves. Frankel and Rose [JIE, 1996], Kwan (JAPE, 1998], Choi [BKEP, 1998], Moreno [FRBSFER, 1999], Kim [APFM, 2000], Grier and Grier [EI, 2001], and others examined the issue and related subjects and showed interesting results. It is interesting to study whether the empirical results are consistent with some of the above hypotheses. Based on the equation of exchange, the regression to be estimated can be expressed as:

GD[P.sub.t] = [[beta].sub.0] + [[beta].sub.1]M[S.sub.t] + [[beta].sub.2]EX[C.sub.t] + [[epsilon].sub.t] , (1)

where GDP, MS, EXO, and [epsilon] denote real GDP, the quantity of money, the exchange rate, and the error term. Data were taken from the database of the International Financial Statistics published by the International Monetary Fund. The sample ranges from 1970.Q2 to 1999.Q4. Variables are measured in the logarithmic scale. Based on generalized least squares, the estimated regression with the t-ratio in parenthesis is presented below:

GD[P.sub.t] = 7.54 + 0.46M[S.sub.t] - 0.13EX[C.sub.t] + [[epsilon].sub.t]; AR(1) = 0.17; [R.sup.2] = 0.94;DW = 2.11 .(2)

(15.02)(18.26) (-1.22) (1.81)

As shown, an increase in the quantity of money is expected to raise real GDP because the coefficient is significant at the 1 percent level. The depreciation of won has not helped the Korean economy in terms of the increase in real GDP because the coefficient of EXC is negative and insignificant at the 10 percent level. The relatively high value of [R.sup.2] suggests that the level of money supply is critical in affecting real GDP.

The finding has a major policy implication. In pursuing the strategy of currency depreciation, some of the nations may overlook potential negative impacts on the economy such as, higher import prices, inflationary pressure, and increased foreign debt. The finding for South Korea suggests that a currency depreciation may not achieve the original goal of increasing real GDP because it may help the export sector but may hurt some of the other sectors. (JEL F4)