Journal of Economic Theory and Econometrics: Journal of the Korean Econometric Society

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Journal of Economic Theory and Econometrics
Journal of the Korean Econometric Society

Reexamination of Fiscal Policy in a Small Open Economy: The Case of Korea

Vol.28, No.2, June , 29–54

English Version |  Korean Version
  •   (College of International Studies, Kyung Hee University)

  •   (Department of Economics, Kyung Hee University)


We empirically estimate the effects of expansionary fiscal policy in Korea to analyze the impacts of the fiscal policy with different exchange rate regime. First, we empirically estimate the Structural VAR to identify the transmission mechanism of major macroeconomic variables from government expenditure shocks in Korea. The government expenditure shocks increase consumption, investment, and GDP. At the same time net exports decrease and foreign exchange rates depreciate in the long run. Second, we set up a small open economy model with financial frictions and discuss the role of financial market frictions in generating a multiplier of government expenditure under PEG and flexible exchange regime. Extended the existing literature on fiscal policy by introducing limited asset market participation and external finance a la Bernanke et al. (1999) into the model. Shown that the multiplier can be larger than one under pegged exchange rate regime, while is smaller than one under flexible exchange rate regime.

   Fiscal Policy, Exchange Rate Regime, Fiscal Mutiplier

JEL classification codes
   E32, E44

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