Monetary shocks on the Korean stock index: structural VAR analysis

This paper investigates the impact of the monetary policies in 3 countries (the Republic of Korea, China and the United States) on the Korean stock markets (e.g., KOSPI), using a structural Vector Autoregression. We find that a positive shock in Money Supply (M2) in all 3 countries is positive to the Korean stock markets but the degree of the response differs from one another. Surprisingly, the response of the KOSPI was largest to China’s M2, reflecting that China is Korea’s largest trading partner. From the responses of Korea’s industrial production and CPI, we speculate that a possibility of liquidity trap was not ruled out in some periods. We also find that the KOSPI responded negatively to a positive shock in Korea’s policy rate while it rarely responded to the shocks in the China’s policy rate and the US federal fund rate. We consider that China’s policy rate did not affect Korea’s economic activities as it was not a main monetary policy tool. We also consider that Korea’s determination of policy rate was not fully free from the US monetary policy and thus any shock in the US federal fund rate was substantially mitigated in the KOSPI.