The Impact of Nominal Effective Exchange Rate on Output and Inflation in Korea

This study investigates the impact of the nominal effective exchange rate on output and inflation under the free floating exchange rate regime in Korea. To achieve this research objective, a vector error correction model is applied to data from the January 1998 to June 2013. The results of vector error correction model analysis show that the nominal effective exchange rate has a positive and significant impact on output in Korea, but that it has an insignificant impact on inflation. The results of a Granger causality test also suggest that a bi-directional causality exists between the exchange rate and output, but that causality does not exist between the exchange rate and inflation. Finally, the results of a robustness test which is executed by adding regressors provide that the regression coefficient estimates remain effective and significant. Thus, we can say that the Korean economy has benefited from an expansion in output owing to exchange rate depreciation, which has had a comparatively lesser impact on inflation under the free floating exchange rate regime.