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Understanding Korea's long-run real exchange rate behavior

Author

Listed:
  • Douglas A. Irwin

    (Peterson Institute for International Economics)

  • Maurice Obstfeld

    (Peterson Institute for International Economics)

Abstract

Korea's real exchange rate has displayed a mild downward trend since the 1980s, with fluctuations of ±20 percent around that trend. This pattern is surprising because the classic Harrod-Balassa-Samuelson framework suggests that countries experiencing rapid growth in the productivity of their tradable industries should experience real currency appreciation over time. The paper decomposes the sources of change behind the Korean won's real exchange rate into internal price drivers (the relative price of nontradable goods) and external price drivers (the international relative price of tradable consumption goods, which is heavily dependent on the nominal exchange rate). The paper finds that, on average, the variability in Korea's real exchange rate, even over long periods, is overwhelmingly due to external price factors. Given the persistent medium-term effects of nominal exchange rate changes on the real exchange rate, the Korean policy of intervening in foreign exchange markets to smooth exchange rate fluctuations appears prudent. However, the paper also find that over the entire period 1985-2023, internal price factors are the main explanator of the won's real depreciation. This finding poses a puzzle for standard accounts of the linkage between productivity growth and real exchange rates.

Suggested Citation

  • Douglas A. Irwin & Maurice Obstfeld, 2024. "Understanding Korea's long-run real exchange rate behavior," Working Paper Series WP24-17, Peterson Institute for International Economics.
  • Handle: RePEc:iie:wpaper:wp24-17
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    Keywords

    Korean won; real exchange rate; Harrod-Balassa-Samuelson model; Baumol-Bowen effect; terms of trade;
    All these keywords.

    JEL classification:

    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
    • F63 - International Economics - - Economic Impacts of Globalization - - - Economic Development
    • N15 - Economic History - - Macroeconomics and Monetary Economics; Industrial Structure; Growth; Fluctuations - - - Asia including Middle East

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