A MONETARY APPROACH TO THE SHORT-RUN ADJUSTMENTS OF REAL OUTPUT, PRICES, AND TRADE BALANCE: THE CASE OF KORE

Traditionally, the monetary approach to the balance of payments theory has focused on the longer-run steady-state relationships between the money market disequilibrium and the balance of payments in an open economy under the assumption of real output and price level being determined independently of monetary disturbances. From the short-run perspective, the assumption of exogenous real output and price level is certainly unrealistic. Some earlier studies included the distinction of tradable and non-tradable sector in their short-run models of the monetary approach to investigate simultaneous determination of the prices and balance of payments.;This dissertation makes a step further in developing a short-run model of the monetary approach by making real output respondent to money supply changes. The transmission mechanism from money supply changes. The transmission mechanism from money to real output does not follow the Keynesian or monetarist' indirect channel through demand-side effect, but adopts supply-side approach, in which desired level of output as derived from a neo-classical production function is constrained by credit availability. In this context, the role of working capital and some financial features of the Korean economy are emphasized. On demand-side, money supply affects real expenditure through the real balance effect of the deviation of actual money holdings from the desired one. The dissertation contains a detailed description of disequilibrium dynamics of prices and trade balance. The former is a consequence of supply-demand inequalities in non-tradable sector, and the latter is a result of supply-demand disequilibrium in tradable sector.;The theoretical model is used to analyze the experience of the Korean economy during the period of 1960-1979 using a simultaneous estimation technique. Several findings are identified. Changes in the money supply have their initial effect most strongly on the output side, with little or even perverse effects on prices and trade balance. After initial period, pronounced real output effect subsides, thus prices and trade balance absorb most of the monetary disturbances. Of the two, trade balance is affected more than the price level, which is consistent with the prediction of long-run monetary model of the balance of payments. It is also found that Korean government was able to control the domestic money stock by effective implementation of sterilization policy and control over the capital flows during the period studied.