Sources of Macroeconomic Fluctuations in Korea

This study investigates the causes of macroeconomic fluctuations in Korea. Based on a model of small open economy, a structural VAR model incorporating cointegrating relations is developed as an analytical framework. It is found that there are two cointegrating relations among the five variables examined, implying there exist three common stochastic trends. A combination of long-run and contemporaneous restrictions is exploited to identify the structural parameters. The result shows that both the aggregate demand and supply shocks are important in explaining the macroeconomic fluctuations in Korea. Supply shocks bear significant responsibility for the fluctuations in income, trade balance and real interest rates whereas demand shocks are equally important as supply shocks for the price movements. Supply (Demand) shocks move output and price in the opposite (same) directions. In addition, trade balance responds negatively to supply shocks, which is consistent with the prediction of real business cycle model.