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

  • Domac, Ilker
  • Ferri, Giovanni

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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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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  1. Lang, William W. & Nakamura, Leonard I., 1995. "'Flight to quality' in banking and economic activity," Journal of Monetary Economics, Elsevier, vol. 36(1), pages 145-164, August.
  2. Kashyap, Anil K & Stein, Jeremy C & Wilcox, David W, 1993. "Monetary Policy and Credit Conditions: Evidence from the Composition of External Finance," American Economic Review, American Economic Association, vol. 83(1), pages 78-98, March.
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  5. Arturo Estrella & Frederic S. Mishkin, 1996. "Predicting U.S. recessions: financial variables as leading indicators," Research Paper 9609, Federal Reserve Bank of New York.
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  9. Frank Browne & Warren Tease, 1992. "The Information Content of Interest Rate Spreads Across Financial Systems," OECD Economics Department Working Papers 109, OECD Publishing.
  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, issue May, pages 63-77.
  12. L. Wade, 1988. "Review," Public Choice, Springer, vol. 58(1), pages 99-100, July.
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