Navigating External Shocks: Capital Flow Responses and Policy Effectiveness in Turbulent Times

This study analyzed the effects of uncertainty and interest rate hike shocks on capital flows, as well as the effectiveness of economic stabilization policies. When comparing the impacts of global economic policy uncertainty shocks and individual country economic policy uncertainty shocks, empirical analysis showed that global economic policy uncertainty shocks had a significant effect on capital flows. This suggests that global factors are more closely associated with capital flows than country-specific factors, relating to discussions on the global financial cycle. Although classified as an advanced economy, Korea has a shallow foreign exchange market and its financial markets are sensitive to external shocks, so the spillover effects of uncertainty shocks need to be analyzed through various channels like trade, capital transactions, industrial structure, and monetary policy. As financial globalization progresses with Fintech and digital finance, the spillover effects of external shocks through capital transactions are expected to increase, especially requiring close monitoring of shocks from countries with similar industrial structures to Korea. An integrated policy framework analysis found that for emerging economies without anchored inflation expectations and shallow foreign exchange markets, a combination of monetary policy and foreign exchange intervention was effective for economic stabilization. Recently, major international organizations like the IMF, BIS, and OECD have shifted towards allowing some foreign exchange intervention and capital flow management measures to reduce exchange rate and capital flow volatility and achieve financial stability. Since there is a general consensus that Korea does not have a deep foreign exchange market, an appropriate combination of monetary policy, foreign exchange intervention, and capital flow management measures can help reduce exchange rate volatility. As Korea's foreign exchange market advances and if Korea succeeds to join major global bond indices, its sensitivity to external factors may increase, so measures to assess the depth and maturity of Korea's foreign exchange and financial markets are needed to determine the optimal policy mix.