KDI Journal of Economic Policy

August 2010, 2010 KDI Journal of Economic Policy Conference

• Chapter 1Lessons on Financial Stability from Japan’s 1980s Bubble Years

  Hyun Song Shin (pp.1-11)

• Chapter 2A Macroprudential Approach to Financial Supervision and Monetary Policy in Emerging Economies

  Yung Chul Park (pp.12-30)

• Chapter 3Thoughts on Modeling Macro-Financial Crisis as Bankruptcy

  Su chan Chae (pp.31-38)

  In this presentation, I would like to share some thoughts in progress. The core idea is that macro-financial crisis can be viewed as bankruptcy in the macro scale. Bankruptcy occurs when existing contractual relations become unsustainable. Thus resolution of crisis requires restructuring contracts. At the macro level, this is a political process. Practical implications of normative solutions in the bargaining and bankruptcy literature need to be investigated. Institutions that are built to insure financial stability such as central banking, deposit insurance and financial regulations can be looked at from the new point of view. In particular, discussions on financial reform should be guided by certain principles that are consistent with macro bankruptcy resolution.

• Chapter 4Issues on Reform of the International Financial Architecture: Korea’s perspective

  Kyung soo Kim (pp.39-57)

  Based upon Korea‘s experience, this paper discusses issues related to reforming the international financial architecture. Foreign reserves, macro-prudential regulation, global financial safety nets and currency internationalization build main framework for reforming IFA. While accumulation of foreign reserves is the most important means of self-protection against deleveraging, without accompanying any macro prudential regulation this will cause significant costs and risk exacerbating the capital inflows problem. Properly designed and implemented macro prudential regulation should mitigate the risk of short term external borrowing. To that extent it can substitute for the hoarding of foreign reserves. However, macro-prudential regulations that are vaguely defined, poorly designed or incorrectly implemented might prevent domestic financial system from functioning properly and bring only short term relief at the cost of longer term benefits from currency internationalization. Global financial safety nets can be useful substitutes for foreign reserves, even though they may be less than perfect.

• Chapter 5International Monetary System Reform and the G20

  조윤제 (pp.58-90)

• Chapter 6

  (pp.91-96)

• Chapter 7Financial Reform in the Post-Crisis Korea and Lessons for Sustainable Growth

  Joon-Kyung Kim ; Chung H. Lee (pp.97-125)

• Chapter 8What Happened to Efficiency and Competition after Bank Mergers and Consolidation in Korea?

  Kang H. Park (pp.126-146)

  Market concentration in the Korean banking industry has markedly increased since the financial crisis of 1997-1998 because of M&As, P&As, and consolidation of banks. With this change, there has been a growing concern over market power in the Korean banking sector. We examine the effects of market concentration on bank efficiency and competition for the period of 1992-2006. Three different indicators of bank inefficiency are used in this study, including X-inefficiency that is derived from the directional technology distance function. This method treats nonperforming loans as an undesirable by-product inevitably arising from the production of loans. The level of competition is measured by the H-statistic of the Panzar-Rosse model and the level of the net interest margin and its standard deviation. Empirical results indicate that market concentration has not improved bank efficiency through scale economies or scope economies. Instead, recent mergers, acquisitions and consolidation of banks resulted in an increase in inefficiency measured by the three different indicators: X-inefficiency, labor inefficiency and asset inefficiency. While an increase in market share of individual banks improved bank efficiency, an increase in the overall market concentration ratio resulted in lower efficiency. Our study also finds that the Korean banking sector has been monopolistically competitive throughout the sample period except for the crisis period according to the H-statistic. Although an increase in market concentration ratio has not changed the overall level of bank competition, it has a positive significant effect on the level of the average interest margin.

• Chapter 9Fundamental Asymmetries in US Monetary Policymaking: Evidence from a Nonlinear Autoregressive Distributed Lag Quantile Regression Model

  Tae-Hwan Kim ; Yong cheol Shin ; Till van Treeck (pp.147-170)

  We identify three general forms of asymmetry that may characterise a wide range of economic processes: reaction asymmetry, adjustment asymmetry and locational asymmetry. The first relates to the possibility that the long-run response of one variable to another may be regime sensitive. The second refers to the case in which the pattern of dynamic adjustment to long-run equilibrium may be state-contingent. The third relates to the notion that an economic relationship may depend upon which conditional quantile of the dependent variable a given observation belongs. Based on a synthesis of the nonlinear ARDL (Autore-gressive Distributed Lag) model developed by Shin, Yu and Greenwood-Nimmo (2009) and the quantile regression approach of Koenker and Bassett (1978), we develop a new empirical framework capable of coherently and simultaneously modelling these three asymmetries. The application of this model to US monetary policymaking over the period 1964q2-2008q2 reveals the following phenomena: (i) The Fed responds linearly to both output and inflation, and does not adhere to the Taylor principle in the lower quantiles of the interest rate, mainly due to the proximity of the zero lower nominal bound; (ii) Between the fortieth and eightieth quantiles, the Taylor principle is upheld for positive inflationary shocks only. Meanwhile, we note significant responses to both positive and negative output gap shocks, with a marked negative asymmetry, suggesting that the Fed acts as an inflation hawk while also displaying a marked tendency toward growth-fostering policies; (iii) Finally, for the uppermost quantiles, we find evidence of very aggressive policy responses to positive and negative inflation and output gap shocks in the context of profound response asymmetry. Hence, we conclude that the degree of policy aggression is a monotonically increasing function of the conditional quantile of the interest rate, and that the common practice of confining one‘s attention to the conditional mean of the dependent variable may obscure important underlying asymmetric effects.

• Chapter 10Estimation of Money Demand Function of South Korea Considering Regime Switching

  Byung Woo Kim (pp.171-200)

  The stability of money demand function is an important issue in macroeconomic policy implementation. In the spirit of Beyer(1998), we estimate money demand of Korean economy. Cointegration test with time dummy variables results show that there is not only long-run equilibrium relationship between money demand and macroeconomic variables, but also structural breaks in this equilibrium relationships. And, least squeres, state-space and Marcov switching methods shows that there also has been instability(or regime shifts) of parameters in money demand, especially over 1997 crisis and the early 2000s. This fact implies that monetary policy for stabilization might encounter big problems due to change(instability) of money demand. In special, targeting for monetary aggregates may be misleading rather than targeting for the interest rate.

• Chapter 11Measures of Underlying Inflation and Evaluation of Inflation Targeting with Global Crisis in Korea

  Won-Am Park (pp.201-227)

  The global financial crisis has exerted enormous impacts on the attainment of inflation target in Korea. The annual average CPI inflation was 3.3% during the targeting period of 2007-2009 and the target was 3.0±0.5%. Thus Korea has succeeded in keeping annual average CPI inflation just below the upper limit of the 2007-2009 target under the global crisis. This paper intends to evaluate the performance of the inflation targeting system in Korea. First, it estimates the conventional call rate reaction equation under the global crisis and finds that the policy interest rates never reacted to expected inflation, output gap, and won/dollar exchange rate, as expected by theory. Second, it identifies the shock of global financial crisis into core and non-core, applying the structural VAR model. The core shock was defined to have no (medium- to) long-run impact on real output. The core shock was identified to have the character of the demand shock, since it has the positive impact on the inflation and output in the short run. The structural core inflation due to core shock was an attractor of headline inflation, not vice versa. Therefore, the structural core inflation that reflects the demand-side shock would be the better intermediate target for the final headline inflation target than the official core inflation that exclude the volatile inflation of agricultural and oil-related products. During the inflation targeting period of 2007-2009, the structural core inflation was more volatile than the official core inflation, because the global crisis has very large negative impacts on the domestic demand as well as the prices of agricultural and oilrelated products. This paper shows that the negative core shock during the fourth quarter of 2008 was larger than that in the financial crisis in 1998. But the core shock turned into positive very quickly in 2009, as the Korean economy recovered very quickly from crisis. The volatile changes in structural core inflation suggests that the Bank of Korea barely managed to attain the 2007-2009 inflation target, owing to the very large negative impacts of the global financial crisis on the domestic demand. It also suggests that the rapid rise in core inflation with the rapid recovery of the Korean economy will lead to rapid rise in headline inflation.

• Chapter 12Central Bank Design and Credit Market Distortions: The Case of Korea

  Peter Tillmann (pp.228-237)

  In the aftermath of the recent financial crisis, special attention is paid to the design of central banks in order to promote economic and financial stability. Often the concept of inflation targeting, i.e. the focus on stabilizing inflation around a prespecified target, is blamed for leading to a too narrow view of economic stabilization that excludes financial stability objectives. The Korean economy was also hit hard by the financial crisis. After a successful decade of inflation targeting, the recent financial crisis made apparent that the functioning of credit market could be a major obstacle to successful economic stabilization. This paper studies the optimal weight the central bank should attach to stabilizing inflation in light of credit market distortions. The paper uses a standard New-Keynesian model, in which the central bank formulates a robust-control approach to monetary policy. Firms hold working capital to finance the wage bill. Both the central bank and the government share the concern about distortions. As a result, a large weight on inflation stabilization remains optimal. The degree of central bank conservatism should increase with the danger of credit market distortions as the stabilization bias of discretionary monetary policy grows with the fear of distortions. The design of the Bank of Korea accords well with these normative findings.

• Chapter 13The Seduction of Bankruptcy

  Yong J. Yoon (pp.238-246)

  Consumer bankruptcy has been rising for three decades until 2005, when the Bankruptcy Abuse Prevention and Consumer Protection Act was enacted. According to the standard theory of bankruptcy, bankruptcy filing is caused by financial distress of consumers. The prediction of this theory is that bankruptcy filings will be cyclical: rising in recession and falling in prosperity. The prediction is consistent with observations until 1979. However, during the 1979-2005 periods, bankruptcy filings have been rising rapidly in spite of strong economic growth. Between 1979 and early 2000s, personal bankruptcy filings increased by more than 400 percent. An alternative explanation considers the fact that the Bankruptcy Reform Act of 1978 has been more forgiving to debtors than earlier laws. This theory considers incentives in rational choice model in explaining the rapid rise in bankruptcy filings. The rational choice theory is not sufficient to explain the fact that the rise took several decades. Considering the stigma people have about filing bankruptcy and the opportunistic behavior, I propose a behavioral theory in which individual behavior results in horizontal evolution. An empirical work has been proposed and performed to compare my proposed theory with the traditional theory. The GINI index is used as a proxy for financial distress. The tentative result based on the data for the 1969 through 2002 indicates that behavioral theory better explains the observed behavior.

• Chapter 14Private Benefits of Corporate Control: Measured from Control Rights Transactions

  Wi Saeng Kima ; Tae Jun Park (pp.247-268)

  This paper utilizes actual data for control rights transactions for Korean firms. This data offer a detailed specific information on the purchase price of the control rights. Utilizing the actual control right transactions data, this paper measures the size of premium associated with the corporate control rights transactions. This study finds that control rights transactions produced positive stock price effects, suggesting that the ownership changes in the Korean market appear to be efficient according to definition offered by Bebchuk (1994). The study also finds that control right premiums vary with firm-specific factors. This finding suggests that private benefits for corporate control are not uniform across all Korean firms, and that some controlling shareholders enjoy more private benefits than other firms, as posited by Bebchuk (1994). Unlike Bargeron et. al (2008) for U.S. block tradings, the study finds that managers for stock exchange listed firms do not pay higher premiums for the corporate control right than for managers of unlisted firms.

• Chapter 15Financial Integration in East Asia Evidence from Stock Prices

  Xiaodan Zhao ; Yoon bai Kim (pp.269-291)

  This paper investigates the extent of global and regional integration in East Asia using stock price index as a measure of economic performance. We employ a structural VAR model to separate the underlying shocks into ―global‖, ―regional‖ and ―country-specific‖ shocks. The estimation results show that country-specific shocks still play a dominant role in East Asia although their role appears to have declined over time, especially after the 1997 financial crisis. Global and regional shocks are responsible for small but increasing shares of stock price fluctuations in most countries. The results indicate that, despite years of liberalization and regional integration, economics in East Asia remain dissimilar and are subject to asymmetric shocks in comparison to European countries. This suggests that it might be costly to abandon monetary policy independence and that a more flexible exchange rate regime might be desirable.

• Chapter 16Seasonality of dividend stock returns

  Youngseok Hahn (pp.292-320)

  This paper reports seasonal price movement of the KOSPI dividend stocks. Based on the last 13 year data from 1997 to 2009, dividend paying stocks settling in March (March stocks) accumulated most of their capital gains during the four months from November to February, close to ex-dividend date. However, returns for the remaining eight months were negligible or negative in these March stocks, the period deemed unattractive to investors as who gets dividend is determined in the end of March. Compared to March stocks, dividend paying stocks settling in December look less affected by the dividend payment, but their monthly returns also revealed the minor impact of dividend payment on their pricing. The seasonality of dividend stock returns is thought to be caused by the seasonal behavioral pattern of dividend investors. They increase the overall demand of dividend stocks as the fiscal year end approaches but reduce the demand after ex-dividend dates. The seasonal behavior is believed to be caused by investors‘ mentality that the dividend factor weighs more in investment decision-making during the selective time period. Given this behavioral pattern, portfolio managers can capture additional return by utilizing the seasonality.

• Chapter 17Business Cycles and Social Spending in Developing Countries: Implications for South Korea’s Foreign Aid Strategy

  Nam suk Kim (pp.321-336)

  The present paper contributes to the literature by providing arguments and evidence on volatility of government expenditure, especially social spending and the role of foreign aid. Empirical findings from government spending data for 27 countries between 1990 and 2008 suggest that social spending is procyclical and more volatile in developing countries, while it is countercyclical and less volatile in advanced economies. Because countries with volatile social spending rely more on foreign aids, donor countries need to concentrate more on social sector aid so that recipient countries can reduce their social spending volatility, and possibly respond to crises in countercyclical manners. South Korea has allocated about half of its foreign aids to social sector, but only with significant fluctuation across time – the coefficient of variation is the highest among donor countries. A steady flow of social sector aid would support the living condition of the poor in developing countries, providing protection when they need it.

• Chapter 18American Pattern Corporate Governance Reforms and Efficiency in Non-American Economy

  Hak Ju Kim ; Wi Saeng Kim (pp.337-348)