The Effect of Exchange Rate Volatility on Economic Growth in South Korea

This paper uses a three-dimensional vector autoregression model to analyze the effect of exchange rate volatility on economic growth and international trade for South Korea, before and after the Asian financial crisis of 1997. Exchange rate volatility is measured as the coefficient of variation of the real effective exchange rate. Economic growth is the quarterly growth rate of real GDP and international trade is the quarterly growth rate of exports plus imports. A onetime, one standard deviation shock to exchange rate volatility leads to a 0.6 percent increase in economic growth in the long run. In the short run however, the effect is negative. A shock to exchange rate volatility leads to an increase in international trade by 3 percent in the five subsequent years, although this effect is statistically insignificant. However, the effect in the short run is a decrease in the growth rate of trade. The Asian financial crisis of 1997 did not have an impact on the relationship between exchange rate volatility and international trade. After the crisis, the negative short-run effect and the positive medium-run effect of exchange rate volatility on economic growth were smaller than in the pre-crisis period. Nevertheless, the long-run effect remained the same.