Conclusion

In recent years, Korea has experienced (i) large capital inflows, in particular a surge in portfolio inflows, and (ii) an appreciation of asset prices such as stock prices, land prices, and nominal and real exchange rates. In this paper we examined how capital inflows, especially portfolio inflows, affect the domestic economy, focusing particularly on asset prices.

We first documented recent trends in capital inflows and asset prices in Korea, and reviewed various theories on how a surge in capital inflows can increase asset prices. Then, we empirically investigated the effects of capital inflows on asset prices by employing a VAR model. The empirical results showed that capital inflows shocks indeed contributed to the stock price increase in Korea, but not much to land prices. Capital inflows shocks had a limited effect on nominal and real exchange rates, which is related to the huge foreign exchange reserve accumulation.

Finally, we discussed the issue of how to manage these capital inflows. As yet, a catchall solution to the problems that capital inflows present does not seem to exist. Therefore, the most should be made of the available instruments at hand.

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