The Responses of Small Open Economies to Foreign Interest Rate Shocks: Considering Structural Break, Net External Credit, and Financial Integration

Cho, Young Moo

Graduate Thesis Or Dissertation

The Responses of Small Open Economies to Foreign Interest Rate Shocks: Considering Structural Break, Net External Credit, and Financial Integration Public Deposited

Analytics

Citations

Citeable URL: https://scholar.colorado.edu/concern/graduate_thesis_or_dissertations/7w62f821k

Abstract

This dissertation enhances our understanding of the effect of foreign interest rate shocks on small open economies. This dissertation investigates related issues such as the result of structural break unit root tests, the role of net external credit (or debt) and financial integration, and the difference in the response of a small open economy based on its categorization. In chapter 2, this study compares various endogenous structural break unit root tests such as the ZA test, the LM test and the KP test. This study points out important drawbacks of the LM test that have been ignored, and also demonstrates practical problems of the KP test. The empirical result implies that the Asian financial crisis seems to be the most significant structural break in most macroeconomic variables of South Korea for the last 20 years. Meanwhile, it turns out that some macroeconomic variables of South Korea still remain nonstationary even after the consideration of a structural break. In chapter 3, this study shows that the Korean economy after the Asian financial crisis demonstrates that, when a small open economy has sizable net external credit, foreign interest rate hikes may cause real expansion due to a positive wealth effect. In addition, the empirical result implies that enhanced financial integration of a small open economy enables foreign interest rate shocks to explain a higher proportion of fluctuations in financial variables of the small open economy. Considering the co-movement of the foreign interest rate with the domestic interest rate of South Korea after the Asian financial crisis, enhanced financial integration seems to make the interest rate channel more important. In chapter 4, this study suggests a new method to categorize small open countries based on net external credit (or debt) and financial integration level. This study shows how responses of developing countries to foreign interest rate shocks differ depending on their categorization. The empirical result based on the Panel VAR methodology shows that overall responses seem to be consistent with the theoretical model that is based on 3 transmission channels.

Creator