Overall and time-varying effects of global and domestic uncertainty on the Korean economy

This study analyzes the overall and time-varying effects of global and domestic uncertainty on the Korean economy by estimating constant parameter and time-varying parameter vector autoregressive models. Global and Korea-specific uncertainty are measured using the method proposed by Mumtaz and Theodoridis (2017). A rise in both the uncertainty measures has an adverse impact on the Korean economy by lowering stock market returns and output growth, and by creating inflation caused by currency depreciation. Quantitatively, the domestic uncertainty shock exercises a larger effect on the Korean economy than the global uncertainty shock, as the former uncertainty shock accounts for about one-fifth of output variation and the latter accounts for about one-tenth. Regarding time-varying effects, substantial increases in domestic uncertainty during the Asian Financial Crisis and global uncertainty during the Global Financial Crisis explain a significant part of macroeconomic fluctuations in Korea during those periods. This is because of the increased volatility of uncertainty shocks during these periods, rather than a structural change in the way these shocks affect the economy.