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The Role Of Foreign Debt And Financial Frictions In A Small Open Economy Dsge Model

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  • MYUNG-SOO YIE

    (Economic Research Institute, Bank of Korea, Seoul 100-794, Korea)

  • BYOUNG HARK YOO

    (#x2020;Department of Economics, Soongsil University, Seoul, South Korea)

Abstract

We examine the role of foreign debt and financial frictions in the Korean business cycle using a small open economy DSGE (dynamic stochastic general equilibrium) model where domestic banks borrow external funds, denominated in foreign currencies, for a risk premium and make loans to domestic producers. We find that the Korean economy is ‘financially vulnerable’, which means that the risk premium increases when the domestic currency depreciates. As a result, depreciation could cause recession, rather than expansion, when there exist substantial amount of foreign debt or financial frictions. A simulation shows that the Korean business cycle would suffer less volatility with a lower steady-state level of foreign debt or no financial frictions.

Suggested Citation

  • Myung-Soo Yie & Byoung Hark Yoo, 2016. "The Role Of Foreign Debt And Financial Frictions In A Small Open Economy Dsge Model," The Singapore Economic Review (SER), World Scientific Publishing Co. Pte. Ltd., vol. 61(05), pages 1-23, December.
    • Handle: RePEc:wsi:serxxx:v:61:y:2016:i:05:n:s0217590815500770
    DOI: 10.1142/S0217590815500770
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    3. Taner Turan & Halit Yanıkkaya, 2021. "External debt, growth and investment for developing countries: some evidence for the debt overhang hypothesis," Portuguese Economic Journal, Springer;Instituto Superior de Economia e Gestao, vol. 20(3), pages 319-341, September.
    4. Yugang He & Moongi Lee, 2022. "Macroeconomic Effects of Energy Price: New Insight from Korea?," Mathematics, MDPI, vol. 10(15), pages 1-14, July.
    5. Yao Li & Yugang He & Renhong Wu, 2023. "Traversing the Macroeconomic Terrain: An Exploration of South Korea’s Economic Responsiveness to Cross-Border E-Commerce Production Technology Alterations in the Global Arena," Sustainability, MDPI, vol. 15(15), pages 1-20, July.

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