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August 2009, 2009 KDI Journal of Economic Policy Conference
Financial Crisis, Recovery and Sustaining Growth-
Chapter 1-1WILL THE U.S. BANK RECAPITALIZATION SUCCEED? LESSONS FROM JAPA
The U.S. government is using a variety of tools to try to rehabilitate the U.S. banking industry. The two principal policy levers discussed so far are employing asset managers to buy toxic real estate securities and making bank equity purchases. Japan used both of these strategies to combat its banking problems. There are also a surprising number of other similarities between the current U.S. crisis and the recent Japanese crisis, The Japanese policies were only partially successful in recapitalizing the banks. We explain why that was the case and then compare the current U.S. plans with those pursued in Japan. While the U.S. plans are still in flux, it appears that U.S. is at risk for running into some of the same problems that hobbled the Japanese policies.
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Chapter 1-2Financial Intermediation and the Post-Crisis Financial System with Implications for Korea
Securitization was meant to disperse credit risk to those who were better able to bear it. In practice, securitization appears to have concentrated the risks in the financial intermediary sector itself. This paper outlines an accounting framework for the financial system for assessing the impact of securitization on financial stability. If securitization leads to the lengthening of intermediation chains, then risks becomes concentrated in the intermediary sector with damaging consequences for financial stability. Covered bonds are one form of securitization that do not fall foul of this principle. I discuss the role of countercyclial capital requirements and the Spanish-style statistical provisioning in mitigating the harmful effects of lengthening intermediation chains. For Korea, the stability of funding emerges as a key consideration. Covered bonds may play a role in stabilizing the funding arrangement for banks.
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Chapter 1-3Sovereign Wealth Meets Market Failure: Government Participation vs Government intervention In Market
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Chapter 2-1Between Two Whales: Korea’s Choice in the Post-Crisis Era
This paper examines the impact of the current global financial meltdown and China‘s rising power on the South Korean economy and South Korea‘s external relations with China and the U.S.
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Chapter 2-2Economic Crisis and Intergenerational Economy: Lessons from Korea’s 1997-98 Economic Crisis
This paper provides insight into some important features of the intergenerational resource allocation in Korea, before and after the financial crisis in 1997-98. Data sets of three periods before and after the financial crisis (1996, 2000, and 2005) were used to compare the results. This research particularly addresses two related issues: i) the generational effects of economic crisis, and ii) the capacity of age reallocation systems to spread economic risks across generations. The results show tremendous consumption smoothing and resource reallocation by age, during and after the financial crisis. Private education and private health consumption decreased for children between 1996 and 2000. However, the decrease in private education and private health consumption was mitigated by the increase in public consumption. It appears that the public sector did not only mitigate the adverse impact of the economic crisis on consumption, but it also reduced the widening disparity amongst generations. Within transfers, the public transfers for the elderly increased substantially as the private transfers decreased rapidly. Finally, there was a big increase in the asset-based reallocation of the elderly. The increase in asset-based reallocation was mainly due to an increase in asset income between 1996 and 2000, but it was almost entirely due to a decrease in saving (i.e. an increase in dissaving) between 2000 and 2005. This suggests that Korean elderly seemed to have some degree of supporting system during the crisis, even without sufficient pension benefits. The increased reliance on asset accumulation will be critical in the long-run in Korea, as public pension funds diminish due to population aging.
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Chapter 2-3Growth of Felonies after the 1997 Financial Crisis in Korea
Ever since the financial crisis in 1997, South Korea has witnessed a sharp increase in felonies (heinous crimes: homicides, robbery, rape, and arson), crimes which directly threatens human body or life. In this paper, we assume that the structural socioeconomic transformation led by the financial crisis increased crimes in this society, and assess the effectiveness of criminal deterrence policy by the Korean government. Our analysis on criminal deterrence policies- policing, sentencing, and corrections – proves that the efforts of Korean government were insufficient to ameliorate the rising trends in crime. For thepast ten years, the investment of human resource and budget in the police has been virtually stagnant, as well as in prosecutors‘ investigation activities, causing a huge decline in arrest rates and prosecution rates. Comparing the pre- and the post-financial crisis period, the average length of prison sentence by the courts has declined. We also found that the increase in the number of repeat offenders convicted of more than a third offense pushed felonies upward, although the government hired more officers and allocated larger budget into prison and probation. In order to curve down the rising crime and prevent possible aggravation of social safety by the current global economic turmoil, it is crucial to invest more resources into criminal deterrence and improve policy effectiveness.
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Chapter 3-1Walking after the Elephant of Financial Crisis
Speculative booms and busts are part of the free enterprise economy. Usually booms burst without much effect in the economy. The current financial crisis looks severer, however. What is noticeable about the procession is the eerie kind of Knightian uncertainty. The elephant of current turmoil tells about the economics profession as much as the economic condition. Economists walk after the elephants in the procession of financial crisis and economic recession. Economists do not seem to provide evidence of expert opinion. Their complaints may not be heard but they must speak with economic logic, and the logic I use in this paper is a public choice analysis. The paper provides a story of the financial crisis from the perspective of risk illusion and politicized mortgage making.
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Chapter 3-2Was There an Explosive Bubble in U.S. Stock Prices before the Recent Stock Market Crash?
Existing studies on bubbles have been mainly concerned with investigating the stationarity properties of stock prices and dividends using unit-root and cointegration tests. However, the standard tests may not be able to detect an important class of bubbles. We develop a model that relates bubble measures to the Weibull distribution. In recent times there were at least three eruptions and subsequent collapses of seeming bubbles: 1987, 2000, and 2007. Using U.S. monthly data from 1980:1 to 2007:10, we have found that only the boom and crash of 2007 represented a bubble, although our stationarity tests fail to detect the bubble. Our results are in agreement with recent findings reported by Bohl (2003) and Nasseh and Strauss (2004).
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Chapter 3-3Testing Financial Contagion with Time-Varying Correlation of Heteroscedastic Asset Returns
We suggest that there is a significant time-varying relationship between cross-market co-movements and predictable market volatility. We demonstrate that the time-varying component of cross-market correlation is attributable to the responses by rational riskaverse investors who systematically revise their expectations in response to changing market volatility. Our results from the time-varying conditional correlation test for contagion show that (a) only the Philippines or the Philippines and Italy show evidence of contagion from the 1997 Asian crisis, and (b) there is no contagion evidence from both the 1994 Mexican peso crisis and 1987 U.S. stock market crash.
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Chapter 3-4Forecasting Time-varying Densities of Inflation Rates: A Functional Autoregressive Approach
This paper utilizes the nonparametric functional autoregressive approach (FAR) to model the time-varying distribution of UK monthly inflation rates using disaggregated cross-sectional data. Our approach is free of any assumptions on the class or structure of the density functions themselves, or the number of dimensions in which the densities may vary. The \\pseudo real time\" in-sample forecasting evaluation results show that our proposed models track the realized event probabilities fairly closely. Furthermore, out-ofsample forecasting results suggest that the mean is projected to be stable at around 2.5%-2.6% over the period March 2008 - February 2009 whilst the uncertainty bands stay between 1.5% and 4% over the 12-month forecast horizon. In addition, the probability of achieving the 2% inflation target is relatively low.
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Chapter 4-1Global Crisis, Official Bailout and the Long-run Demand for Official Lending
This paper presents an analysis of official bailout and emerging market debt structures and uses the analysis to argue that even in the absence of moral hazard an increased supply of official lending may create its own demand in the long run by encouraging risky shortterm debt. In the analysis, short-term debt runs the risk of a rollover crisis and inefficient default but cheaper than long-term debt. Official bailout helps prevent default but only at the expense of long-term investors whose claims are subordinated to senior official loans. By increasing the relative price of long-term debt, official bailout biases the debt structure of the country toward more short-term debt than otherwise. The bias increases with the size of official lending if the latter is initially small. These results suggest that the recent reform of IMF lending facilities and funding options could lead to a higher long-run demand for official lending than might be warranted by the fresh market perception of the risk of global liquidity shock.
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Chapter 4-2외환관리 정책의 재조명과 바람직한 외환정책
As Korea's current account deficit swelled in 2008, global financial market anxiety stemming from the US subprime crisis deepened and a dollar liquidity crunch hit Korea's foreign exchange (FX) market. The won/dollar rate in turn shot up, as did exchange rate volatility. In fact, though the currencies of most emerging market economies were weakened by the crisis-induced global liquidity crunch, Korea saw both the largest spike in its CDS premium and the most severe devaluation of its currency. It is thus viewed as having had much higher FX market instability than other countries. The external shock of the global crisis was in part, of course, beyond the control of domestic policy makers and financial markets. Nonetheless, it is highly likely that Korea's greater instability relative to other emerging market economies was to a degree rooted in the side effects of Korea's dramatic shift in FX policy following the 1997 currency crisis. Korea's post-currency crisis policies encouraged currency inflows through capital market opening and FX market liberalization. From 2006, however, these policies were reversed to combat the excessive strengthening of the won. Especially, at the time currency outflow policies were adopted, Korea's current account surplus had been declining and there was a massive exodus of non-debt foreign equity capital. In addition, there was a large inflow in foreign debt capital, such as foreign investment in domestic bonds and short-term borrowing. However, the currency outflow policy focused on increase to investment of non-debt equity capital in abroad. In a result, after the crisis, debt capital owned by foreign investors was easy to be outflowed but nondebt capital owned by domestic investors was not and foreign exchange liquidity got tightened. In light of the recent global financial crisis, some have asserted that Korea need over US$300 billion of currency reserves to stabilize foreign exchange market. However, any discussion about the appropriate amount of currency reserves should, however, take the follow items into consideration. First, although greater currency reserves may bolster the capacity to deal with a crisis and boost overseas credit ratings, the costs and benefits of doing so must be weighed. Second, artificially replenishing currency reserves to keep them at a specific level may induce speculative trading and is thus considered to be inappropriate. Therefore, it will be necessary to let currency reserves rise naturally from the rise in currency reserves from sterilization policy, increased central bank profits and etc. Desirable exchange policies must have FX market stability, that is, rate stability, as the goal. To achieve this, Korea should consider the following measures over market intervention. First, to stabilize currency liquidity, currency swaps and other forms of international cooperation should be strengthened, in addition to bolstering economy fundamentals. Second, so as not to stray from market opening and liberalization, FX measures related to boosts domestic currency outflows must be reexamined and inflow of foreign long-term investment must be attracted through incentives and grants. Third, to ensure that foreign debt does not rise as a result of excessive financial institutions' competition for asset growth, it will be necessary to regulate the oversight of currency soundness. Finally, in the long term, the internationalization of the won must continue to be pursued through expanding local settlement in won and through other measures.
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Chapter 4-3자본시장의 글로벌화와 한국 통화정책의 독립성
This paper empirically examines whether Korean monetary policy is independent of U.S. monetary policy during the post-crisis period in which capital account is liberalized and floating exchange rate regime is adopted and during the pre-crisis period in which capital mobility is restricted and tightly managed exchange rate regime is adopted. Before capital account liberalization, monetary autonomy can be achieved in view of the trillema, even under tightly managed exchange rate regime, as capital mobility is restricted. On the other hand, for the period after capital account liberalization, monetary autonomy can be also achieved in view of the trillema, as exchange rate stability is given up. Securing monetary autonomy, however, may not be easy under liberalized capital account for a small open economy like Korea. Huge capital movements can generate excessive instability in foreign exchange and asset markets. Strengthened international economic linkages may also be another factor to prevent monetary policy from being independent. Using blockexogenous structural VAR model, the effects of U.S. monetary policy shocks on Korean economy are examined. Empirical results show that Korean monetary policy is not independent of U.S. monetary policy for both periods before and after capital account liberalization. For the period after capital account liberalization, Korea does not seem to have implemented floating exchange rate policy in practice, which may lead Korean monetary policy to be dependent on U.S. monetary policy. For the period after capital account liberalization, portfolio flows respond dramatically to the U.S. monetary policy, which may also keep Korean monetary policy from being independent.
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Chapter 4-4Financial Market Integration in East Asia: Status and Options
As cross-border capital movements are expanding, financial markets in East Asia are becoming increasingly integrated. This paper attempts to investigate the current state of financial market integration in East Asia by measuring interest differentials among 10 East Asian countries along with various factors that determine these differentials. According to this paper, there is increasing interest rate convergence in East Asia although the interest deviations remain high compared to Europe. Also, the predominant obstacle preventing further integration is the increasing level of exchange rate fluctuations in East Asia. Given that successful financial market integration necessitates exchange rate stability, it is essential to establish an effective regional monetary institution in East Asia.
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