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The real impact of financial shocks : evidence from the Republic of Korea

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  • Domac, Ilker
  • Ferri, Giovanni

Abstract

The debates surrounding the recent East Asian crisis have focused not only on causes but also on policy actions in the wake of the initial shock. This has raised questions about the relationship between monetary policy and market confidence. Specifically, would rising interest rates bolster or depress market confidence? To answer this question requires assessing whether, and to what extent, monetary and financial shocks are magnified through the economy via the credit channel. The authors focus on the Republic of Korea - a particularly good case for testing credit channel effects - with two objectives: a) To ascertain whether and to what extent interest rate spreads could help predict subsequent fluctuations in real economic activity. b) To test whether small and medium-size enterprises suffer more than other business do from the adverse effects of the credit channel. The author's empirical findings support the hypothesis that spreads that capture credit channel effects do indeed influence economic activity. Specifically, spreads contain significant information for predicting the future course of industrial production. The effect is, as one might have assumed, disproportionately larger for small and medium-size enterprises. Thus policymakers, in Korea and elsewhere, who neglect credit channel effects might be"overkilling the economy"and altogether overlooking the disproportionate effects of monetary and financial shocks on various segments of the economy.

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Bibliographic Info

Paper provided by The World Bank in its series Policy Research Working Paper Series with number 2010.

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Date of creation: 30 Nov 1998
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Handle: RePEc:wbk:wbrwps:2010

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Keywords: Economic Theory&Research; Financial Intermediation; Environmental Economics&Policies; Payment Systems&Infrastructure; International Terrorism&Counterterrorism; Environmental Economics&Policies; Banks&Banking Reform; Financial Intermediation; Financial Crisis Management&Restructuring; Economic Theory&Research;

References

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  1. Arturo Estrella & Frederic S. Mishkin, 1996. "Predicting U.S. recessions: financial variables as leading indicators," Research Paper, Federal Reserve Bank of New York 9609, Federal Reserve Bank of New York.
  2. Anil K Kashyap & Jeremy C. Stein & David W. Wilcox, 1992. "Monetary Policy and Credit Conditions: Evidence From the Composition of External Finance," NBER Working Papers 4015, National Bureau of Economic Research, Inc.
  3. R. Glenn Hubbard, 1995. "Is there a "credit channel" for monetary policy?," Review, Federal Reserve Bank of St. Louis, Federal Reserve Bank of St. Louis, issue May, pages 63-77.
  4. Harper, Charles P, 1977. "Testing for the Existence of a Lagged Relationship within Almon's Method," The Review of Economics and Statistics, MIT Press, vol. 59(2), pages 204-10, May.
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  6. L. Wade, 1988. "Review," Public Choice, Springer, Springer, vol. 58(1), pages 99-100, July.
  7. Benjamin M. Friedman & Kenneth N. Kuttner, 1998. "Indicator Properties Of The Paper-Bill Spread: Lessons From Recent Experience," The Review of Economics and Statistics, MIT Press, vol. 80(1), pages 34-44, February.
  8. Ben S. Bernanke & Alan S. Blinder, 1988. "Credit, Money, and Aggregate Demand," NBER Working Papers 2534, National Bureau of Economic Research, Inc.
  9. Stiglitz, Joseph E & Weiss, Andrew, 1981. "Credit Rationing in Markets with Imperfect Information," American Economic Review, American Economic Association, American Economic Association, vol. 71(3), pages 393-410, June.
  10. Anil K Kashyap & Jeremy C. Stein, 1997. "What Do a Million Banks Have to Say About the Transmission of Monetary Policy?," NBER Working Papers 6056, National Bureau of Economic Research, Inc.
  11. R. Glenn Hubbard, 1995. "Is there a "credit channel" for monetary policy?," Proceedings, Federal Reserve Bank of St. Louis, Federal Reserve Bank of St. Louis, issue May, pages 63-77.
  12. Frank Browne & Warren Tease, 1992. "The Information Content of Interest Rate Spreads Across Financial Systems," OECD Economics Department Working Papers 109, OECD Publishing.
  13. Lang, William W. & Nakamura, Leonard I., 1995. "'Flight to quality' in banking and economic activity," Journal of Monetary Economics, Elsevier, Elsevier, vol. 36(1), pages 145-164, August.
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Citations

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Cited by:
  1. Costa, Stefano & Malgarini, Marco & Margani, Patrizia, 2012. "Access to credit for Italian firms: new evidence from the ISTAT confidence business surveys," MPRA Paper 41389, University Library of Munich, Germany.
  2. Khan, Haider, 2013. "Basel III, BIS and Global Financial Governance," MPRA Paper 49513, University Library of Munich, Germany.
  3. Mathinee Subhaswasdikul & Don Nakornthab, 2003. "Banking Sector Fundamentals: Learning from the Recent Bank Lending Contraction," Working Papers, Economic Research Department, Bank of Thailand 2003-11, Economic Research Department, Bank of Thailand.
  4. Antonio Forte & Giovanni Pesce, 2009. "The International Financial Crisis: an Expert Survey," series, Dipartimento di Scienze Economiche e Metodi Matematici - Università di Bari 0024, Dipartimento di Scienze Economiche e Metodi Matematici - Università di Bari, revised Apr 2009.
  5. Khan, Haider, 2013. "Deep Financial Crises, Reforming the IMF and Building Regional Autonomy:Towards a New Hybrid Global Financial Architecture," MPRA Paper 49514, University Library of Munich, Germany.
  6. Borensztein, Eduardo & Lee, Jong-Wha, 2002. "Financial crisis and credit crunch in Korea: evidence from firm-level data," Journal of Monetary Economics, Elsevier, Elsevier, vol. 49(4), pages 853-875, May.
  7. Stephanos Papadamou & Costas Siriopoulos, 2012. "Banks’ lending behavior and monetary policy: evidence from Sweden," Review of Quantitative Finance and Accounting, Springer, Springer, vol. 38(2), pages 131-148, February.
  8. Khan, Haider, 2013. "Global Financial Governance: Towards a New Global Financial Architecture for Averting Deep Financial Crises," MPRA Paper 49275, University Library of Munich, Germany.
  9. Raditya Sukmana & Salina H. Kassim, 2010. "Roles of the Islamic banks in the monetary transmission process in Malaysia," International Journal of Islamic and Middle Eastern Finance and Management, Emerald Group Publishing, Emerald Group Publishing, vol. 3(1), pages 7-19, April.
  10. Haider Ali Khan, 2003. "General Conclusions: From Crisis to A Global Political Economy of Freedom," CIRJE F-Series, CIRJE, Faculty of Economics, University of Tokyo CIRJE-F-192, CIRJE, Faculty of Economics, University of Tokyo.
  11. Sung Jin Kang & Yasuyuki Sawada, 2008. "Credit Crunch And Household Welfare, The Case Of The Korean Financial Crisis," The Japanese Economic Review, Japanese Economic Association, Japanese Economic Association, vol. 59(4), pages 438-458.
  12. Tobias Knedlik & Johannes Ströbel, 2006. "The role of banking portfolios in the transmission from currency crises to banking crises - potential effects of Basel II," IWH Discussion Papers, Halle Institute for Economic Research 21, Halle Institute for Economic Research.
  13. Khan, Haider, 2011. "Constructing Global Governance of Global Finance: Towards a Hybrid Global Financial Architecture," MPRA Paper 40249, University Library of Munich, Germany, revised Jan 2012.
  14. Maethinee Supsawaddkul & Don Nakornthap, 2002. "Banking Sector Fundamentals: Learning from the Recent Bank Lending Contraction," Working Papers, Economic Research Department, Bank of Thailand 2002-02, Economic Research Department, Bank of Thailand.

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