한국개발연구. Vol. 13, No. 2, August 1991, pp. 3-19
This paper attempts to identify key determinants of long run movements of real M2 by using the Johansen procedure for estimating and testing cointegration relations. It turns out that the real M2 equation has been stable over the long run despite rapid changes in financial structure since 1975. Moreover, the real M2 equation can be reduced to a velocity equation with the opportunity cost variable, expected inflation less the weighted average rate paid on M2 deposits, being the key determinant. However, it does not work to use a market interest rate such as the yield on corporate bonds in place of expected inflation for calculation of the opportunity cost. In the U.S., a market interest rate can be used, but not in Korea. Presumably, two somewhat different reasonings can be used to explain this result. One is that the yield on corporate bonds may not adequately reflect the inflationary expectations due to regulations on movements in interest rates. The other is that M2 deposits are not readily substitutable with such assets as corporate bonds because of market segmentations, regulations, and so on. From the policymaker's point of view, this implies that the inflation rate is an important indicator of a policy response. On the other hand, policymakers do not regard movements of the yield on corporate bonds as an important policy indicator. Altogether, the role of interest rates has been quite limited in Korea because of incomplete interest rate liberalization, an underdeveloped financial system, implementation procedures of policy measures, and so on. The result that M2 velocity has a positive cointegration relation with expected inflation minus the average rate on M2 implies that frequent adjustments of the regulated rates on M2 will be necessary as market conditions change. As the expected inflation gets higher, M2 velocity will eventually increase, given that the rates on M2 do not change. This will cause higher inflation. If interest rates are liberalized, then increases in market interest rates will result in lagged increases in deposits rates on M2. However, in Korea a substantial portion of deposit rates are regulated and will not change without the authority's initiatives. A tight monetary policy will cause increases in a few market interest rates. But the market mechanism, upward pressure for interest rate adjustments, never reaches regulated deposit rates. Hence the overall effects of tight monetary policy diminish considerably, only causing distortions in the flow of funds. Therefore, frequent adjustments of deposit rates are necessary as market conditions such as inflationary expectations change. Then it becomes important for the policymaker to actively engage in adjusting regulated deposit rates, because the financial sector in Korea is not fully developed.