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The Global Crisis and Korea's International Financial 20335_COVER-R2.qxd:20335_COVER-R2 11/11/09 9:23 AM Page 1 T HE G LOBAL C RISIS AND K OREA ’ S I NTERNATIONAL THE GLOBAL CRISIS AND A very readable assessment of Korea’s international economic policies that is deeply grounded in global financial history, Korea’s institutions, and facts. The recent global crisis provides a focus, but the perspective reaches back to the KOREA’S INTERNATIONAL 1997–98 Asia crisis; the recommendations would, if adopted, serve Korea well in both stable times and stressful ones, and merit study by other countries as well. F –– Jeffrey Shafer, Vice Chairman, Global Banking, Citigroup INANCIAL FINANCIAL POLICIES P OLICIES Thomas D. Willett With contributions by Nancy N. Auerbach Thomas D. Willett Kenneth S. Kim Yoonmin Kim Alice Ouyang Orawan Permpoon Thana Sompornserm Lalana Srisorn Ozan Sula KOREA ECONOMIC INSTITUTE SPECIAL 1800 K Street, NW, Suite 1010 Washington, DC 20006 STUDIES SERIES: 5 Telephone (202) 464-1982 • Facsimile (202) 464-1987 • www.keia.org The Global Crisis and Korea’s International Financial Policies Thomas D. Willett With contributions by Nancy N. Auerbach Kenneth S. Kim Yoonmin Kim Alice Ouyang Orawan Permpoon Thana Sompornserm Lalana Srisorn Ozan Sula Korea Economic Institute • 1800 K Street NW, Suite 1010 • Washington, DC 20006 Telephone 202/464-1982 • Facsimile 202/464-1987 • Web address www.keia.org 20335_SpcStd_Willett-N1-R1.indd 1 11/11/2009 4:02:02 PM The Korea Economic Institute (KEI) is registered under the Foreign Agents Registration Act as an agent of the Korea Institute for International Economic Policy, a public policy research foundation in Seoul established by the Government of the Republic of Korea. This material is filed with the Department of Justice, where the required registration statement is available for public inspection. Registration does not indicate U.S. Government approval of the contents of this document. KEI is not engaged in the practice of law, does not render legal services, and is not a lobbying organization. The views expressed in this paper are those of the authors and do not necessarily reflect the views of individual members of KEI’s Board of Directors or its Advisory Council. KEI Editorial Board Editor in Chief James M. Lister Contract Editor Mary Marik Assistant Editor Arthur N. Taylor © 2009 by the Korea Economic Institute All rights reserved Printed in the United States of America Library of Congress Cataloging-in-Publication Data Willett, Thomas D. The global crisis and Korea’s international financial policies / Thomas D. Willett ; with contributions by Nancy N. Auerbach ... [et al.]. p. cm. Includes bibliographical references. ISBN 978-0-9747141-9-6 1. Finance--Korea (South) 2. Monetary policy--Korea (South) 3. Global Financial Crisis, 2008-2009. I. Title. HG187.K6W55 2009 332’.042095195--dc22 2009042680 20335_SpcStd_Willett-N1-R1.indd 2 11/11/2009 4:02:02 PM Contents Foreword iv Preface v 1 Introduction and Overview 1 2 Korea’s Exchange Rate Policies between the Crises 11 3 Dangers of Pegged Exchange Rates and Advantages of 39 Inflation Targeting 4 International Reserve Adequacy 48 5 Financial Liberalization and International Capital Flows 58 6 International Aspects of Korea’s Monetary Policies 76 7 Creating a Common Asian Currency Is the Wrong Approach to 89 Asian Monetary and Exchange Rate Cooperation 8 Geopolitical Considerations and Lessons from Europe for 109 Monetary and Financial Cooperation in Asia 9 Similarities and Differences between the 1997–98 Crisis and 118 the Current One 10 Crisis Hits Korea 125 11 Conclusions and Policy Recommendations 137 Appendix A: Econometric Estimates of Sterilization and Offset 147 Coefficients for Korea Appendix B: Tables in Support of Appendix A 153 List of References 157 20335_SpcStd_Willett-N1-R1.indd 3 11/11/2009 4:02:03 PM Foreword The Korea Economic Institute (KEI) is pleased to issue the fifth volume of its “Special Studies” series. This series affords individual authors an opportunity to explore in depth a particular topic of current interest relating to Korea. Completion of this study is timely. Its planning commenced well before the bankruptcy of Lehman Brothers and ensuing broadening of the turbulence in U.S. financial markets into a global financial crisis and then a severe economic slowdown. However, its comprehensive assessment of Korea’s international financial policies, with a foray into the feasibility of an Asian common cur- rency, takes on greater relevance in light of these events and the early recov- ery of Korea’s economy and financial markets. Dr. Thomas D. Willett, assist- ed by a number of coauthors of individual chapters and sections, provides not only a comprehensive assessment of Korea’s policies but also considerable insight into issues such as the adequacy of foreign exchange reserves that are part of the debate on reform of the international financial architecture. KEI is dedicated to objective, informative analysis. We welcome comments on this and our other publications. We seek to expand contacts with academic and research organizations across the country and would be pleased to enter- tain proposals for other “Special Studies.” Charles L. (Jack) Pritchard President October 2009 20335_SpcStd_Willett-N1-R1.indd 5 11/11/2009 4:02:03 PM Preface I have accumulated many debts in the preparation of this study. Chapter 2 draws heavily on a paper with Kim Yongbok, “Assessing Korea’s Post Crisis Managed Float,” that was prepared for a Bank of Korea workshop in 2004. A shortened version of that paper written with Kim Yongbok was published by the Korea Economic Institute in Korea’s Economy 2006, with the title “Korea’s Postcrisis Exchange Rate Policy.” Chapter 2 has been substantially revised and updated with the assistance of coauthor Kenneth S. Kim, current Claremont Graduate University dissertation student. After completing his dissertation at Claremont, Kim Yongbok returned to the Bank of Korea, and neither he nor the Bank has responsibility for the policy views expressed. Chapter 2 as well as portions of Chapters 9 and 10 benefited from helpful comments by participants in the 2009 annual meetings of the Asia-Pacific Economic Association and Western Economic Association International. Chapter 4 on the subject of demand for international reserves was cowritten with recent Claremont graduate Ozan Sula and draws on earlier research of Jung Sik Kim et al. (2004) for the Claremont-KIEP Conference on Monetary and Exchange Rate Arrangements in East Asia. Chapter 5 on financial liberalization and international capital flows is coauthored with current Claremont doctoral students Yoonmin Kim and Thana Sompornserm. Professor Nancy N. Auerbach of Scripps College is coauthor of the first section of Chapter 5, which draws heavily on our joint paper, “The Political Economy of Perverse Financial Liberalization,” presented at a conference on the Korean economy at the University of Washington. Yoonmin Kim is also coauthor of section 2 of Chapter 10. Chapter 6 on international dimensions of Korean monetary policy was cowritten with recent Claremont graduate Alice Ouyang, who is now on the faculty at the Central University of Finance and Economics in Beijing. She is the primary author of Appendix A and Appendix B on the estimation of sterilization and offset coefficients. Chapters 7 and 8 draw heavily on the research for my joint paper, entitled “Asian Monetary Cooperation: Perspectives from the European Experience and Optimum Currency Area Analysis,” written with recent Claremont graduate Orawan Permpoon, now with the Thai Ministry of Foreign Affairs, and current Claremont dissertation student Lalana Srisorn. This was first presented in November 2007 at a joint Claremont-KEI-KIEP workshop on the subject of Asian monetary cooperation at which many highly useful comments 20335_SpcStd_Willett-N1-R1.indd 7 11/11/2009 4:02:03 PM were received. Orawan is coauthor of Chapter 7 of this study, and Lalana is coauthor of Chapter 8. This study draws more broadly on the ongoing research projects of the Claremont Institute for Economic Policy Studies on Asian economic cooperation, on currency and financial crises, and on reform of the international financial architecture. Financial support for this underlying research from the Freeman Foundation, KEI, and the National Science Foundation is gratefully acknowledged, as are the skills of the Institute’s able administrator, Lynda Marquez, and my assistant, Lalana Srisorn. Extremely valuable comments by M. K. Kang, James Lister, Kwanho Shin, and Ted Truman on the entire manuscript and by Helen Popper on Chapter 2 are also gratefully acknowledged. Thomas D. Willett Director, Claremont Institute for Economic Policy Studies and Horton Professor of Economics Claremont Graduate University and Claremont McKenna College 20335_SpcStd_Willett-N1-R1.indd 8 11/11/2009 4:02:03 PM 1 Introduction and Overview The global crisis that was ignited by the meltdown in the U.S. subprime mortgage market is a dramatic illustration of just how interdependent our economic and financial systems have become. The spread of the crisis from a downturn in a major real sector of the U.S. economy to the financial market most connected to it was to be expected. What caught many people, includ- ing experts, by surprise was how the crisis kept spreading to a much wider set of financial and credit markets in the United States and other industrial countries, then to a much broader set of countries around the globe—and then from the financial to the real sectors. The resulting recessions in the indus- trial countries spread the damage to many developing and emerging-market countries that had little direct financial connection with the fancy derivatives products that contributed so much to the initial spread of the crisis. In this process, Korea was in an intermediate position. It had little direct exposure to securities based on the U.S. subprime market, but its high level of financial interdependence made it the Asian country hardest hit when global financial markets seized up.
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