Capital flows and exchange rates: recent Korean and Taiwanese experience and challenges

We first study the characteristics of the financial crisis and its impacts on Taiwanese and Korean economies. We have examined 22 macroeconomic fundamentals, such as GDP, inflation rates, government budget, trade balance, external debt, money supply, and ratios of average monthly imports and cumulative inward portfolio investment to international reserves, and compared with an extensive data set of the two countries. The comparisons point out that the macrofundamentals of both countries are basically the same, except the international finance sector. After defining currency crisis and banking crisis, the causes of crises are identified as the nominal exchange rates and the short-term external debt-to-international reserves ratios. In view of this, we use cointegration and causality tests to examine the relationship between these two time series. We have found a unidirectional causality from the short-term debt ratio to the exchange rate for Korea, but no causality between the two for Taiwan. The paper ends with some discussions on the lessons and challenges from the experience of the two countries.