News and Business Cycles for Korea

How important is ``news'' about not-yet-realized economic fundamentals in macroeconomic fluctuations for Korea? To address this question, this paper estimates a small open economy real business cycle model embedded with the anticipated components of exogenous shocks. Three main findings emerge based on an analysis of Korean data ranged from 1960:Q2 to 2014:Q4. First, a substantial fraction of the variability of output, consumption, and investment is accounted for by unanticipated shocks. Anticipated shocks play a critical role in causing fluctuations in government spending and trade balance, but their business cycle implications are weak. Second, the contribution of anticipated shocks to output and consumption fluctuations increases from the late 1980s to the onset of the Asian currency crisis of the late 1990s. Anticipated shocks account for a dominant fraction of investment variability during the recession period associated with the Asian currency crisis, and of trade balance movements in the post-crisis period. Finally, the financial friction mechanism, in which the country's interest rate spread is dependent upon the level of sovereign debt, has substantial implications for the output and investment dynamics in the model.