The effects of government spending shocks on the trade account balance in Korea

This paper investigates fiscal policy effects on the trade account balance in Korea using open economy vector autoregressive (VAR) models. In response to fiscal spending shocks, real appreciations occur, followed by deteriorations in the trade account balance with the pre-2000 sample period, while real depreciations occur leading to an improvement in the trade account balance with the post-2000 sample period. We explain this structural break in relation to Korea's transition from a tightly managed exchange rate regime to a more market-oriented floating system after Korea's foreign exchange crisis in 1997-98. Furthermore, such fiscal policy effects from our post-2000 sub-sample imply that expansionary fiscal policy can be effective in stimulating private sector economy in Korea.