effect of GDP on dollar exchange rate for Korean Won

The value of a home currency is determined by the exchange rate. To keep the national currency stable is one of central banks’ principal goals. Politics and economy, both internal and external to the economy, play a role in the stability of the national currency (Murali 346). The GDP of the home currency is one of the elements that influences the exchange rate. We will examine the effect of GDP on the value of the Korean won in this study.

The measure of an economy’s level of production is its GDP. The GDP often reflects the size of the economy. Therefore, countries with a larger population size and geographical size are likely to have a higher rate of GDP. There is no direct measure of the level of GDP for a country. Therefore, GDP is obtained from the calculation of other aspects of the economy. The main components of the GDP are government expenditure, consumption, imports, exports, and investments (Colander 68).

In this study, various variables will be used to represent each of the components of the GDP as well as other exogenous variables. The variables to be used in the study are US and Korea GDP, imports, exports, foreign direct investments (FDI) and interest rates. All these variables have a relationship with the dollar exchange rates for the Korean won and the country’s GDP.

Data Description

This study will use quantitative economic data for both the use and Korean economies. A correlational analysis will be conducted to first determine the relationship between the independent variables and the dependent variable. The dependent variable in the study is the dollar exchange rate of the Korean Kwon. The independent variables for the study are the US GDP, Korean GDP, imports, exports, FDI and the interest rates in Korea.

Exchange Rate

The dollar exchange rate of the Korean won will be used as the dependent variable for the study. It represents the relative value of the home currency against other currency. The value of various currencies fluctuates often. Since there is no fixed exchange rate, the exchange rate for the Korean won is compared to the US dollar. An increase in the value of exchange rates implies that the value of the currency has decreased. Moreover, a decrease in the numerical value of the exchange rates would suggest that the value of the currency has increased. The table below shows the descriptive statistics for the exchange rate.

Exchange rate

Mean

958.0638611

Standard Error

35.25095537

Median

940.273

Standard Deviation

211.5057322

Sample Variance

44734.67475

Kurtosis

-1.127709456

Skewness

0.228732965

Range

794.004

Minimum

607.433

Maximum

1401.437

Sum

34490.299

Count

36

The minimum exchange rate is 607.433 while the maximum exchange rate is 1401.437. The average exchange rate is 958.06 with a standard deviation of 211.51. In this data, the exchange rate shows the value of one US dollar in Korean won. Therefore, when the exchange rate increases, the value of the Won decreases. When the exchange rate decreases, the value of the Won increases.

GDP

GDP is the measure of the quantity of production in an economy. It is usually measured by valuing all the goods and services that were produced within a period of time. A higher value of the GDP implies that the economy has produced more while a lower value of the GDP implies that the economy has produced less. In this study, both the GDP for the US and Korea will be presented. GDP for both countries is valued at constant 2010 dollar value. The table below shows the descriptive statistics for both US and Korea.

GDP (Korea)

GDP (US)

Mean

6.51E+11

Mean

1.1465E+13

Standard Error

5.9E+10

Standard Error

5.3897E+11

Median

6.08E+11

Median

1.14181E+13

Standard Deviation

3.54E+11

Standard Deviation

3.23382E+12

Sample Variance

1.25E+23

Sample Variance

1.04576E+25

Kurtosis

-1.25944

Kurtosis

-1.434642952

Skewness

0.199194

Skewness

-0.027575827

Range

1.12E+12

Range

1.00683E+13

Minimum

1.49E+11

Minimum

6.52917E+12

Maximum

1.27E+12

Maximum

1.65974E+13

Sum

2.34E+13

Sum

4.1274E+14

Count

36

Count

36

The minimum GDP in Korea is 1.49E+11 while the maximum GDP is 1.27E+12. The minimum GDP in the US is 6.52917E+12 while the maximum GDP is 1.65974E+13. The average GDP for Korea is6.51E+11 while the average GDP for the US is 1.1465E+13. This shows that the Ushas a higher GDP than Korea.

Imports

Imports are the goods and services that are sold within the economy but are not produced in the economy. Imports have an adverse impact on the level of GDP in the economy. Therefore, when imports are high, the level of GDP is low. When imports are low, the level of GDP is likely to increase. Importation of goods and services in the economy reduces the demand for local goods while increasing the supply of the imported goods (Gregory and Mark 249). The value of Korean imports is measured in US dollars. The table below shows the descriptive statistics for Korean Imports.

Imports

Mean

2.47692E+11

Standard Error

33286755327

Median

1.97367E+11

Standard Deviation

1.99721E+11

Sample Variance

3.98883E+22

Kurtosis

-0.917694873

Skewness

0.662881542

Range

6.01009E+11

Minimum

30224757285

Maximum

6.31234E+11

Sum

8.91692E+12

Count

36

The minimum value of imports is 30224757285 while the maximum value is 6.31234E+11. The average value of imports is 2.47692E+11.

Exports

Exports are the locally produced goods and services that are sold to other economies or markets. An increase in exports leads an increase in the GDP for the economy. A decrease in exports leads to a reduction in the level of GDP. The Korean imports are valued in US dollars. The table below shows the descriptive statistics for Korean imports.

Exports

Mean

2.41292E+11

Standard Error

38526137284

Median

1.49872E+11

Standard Deviation

2.31157E+11

Sample Variance

5.34335E+22

Kurtosis

-0.686011816

Skewness

0.85062888

Range

6.83273E+11

Minimum

18282725222

Maximum

7.01555E+11

Sum

8.68652E+12

Count

36

The minimum value of imports is 18282725222, and the maximum value of exports is 7.01555E+11. The average value of exports is 2.41292E+11.

Foreign Direct Investment

FDI measures the value of direct investments flowing into the country from the community. There is an established positive correlation between the FDI in an economy and the level of GDP. When FDI is high, the level of GDP also increases. Also, when FDI is low, the level of GDP decreases. This is because the FDI increases the level of productivity in the economy. The value of the foreign direct investments is measured as the net dollar value of investments. This is calculated as the difference between the inflow of direct investments and the outflow of direct investments from the economy. Therefore, a negative value of FDI implies that investment outflows were greater than inflows while a positive value of FDI implies that the inflows are greater than the outflows. The table below shows the descriptive statistics for Korean FDI.

FDI

Mean

3322863889

Standard Error

1352384170

Median

194250000

Standard Deviation

8114305019

Sample Variance

6.58419E+19

Kurtosis

0.136585037

Skewness

1.144782854

Range

27895300000

Minimum

-6759100000

Maximum

21136200000

Sum

1.19623E+11

Count

36

The average FDI is 3322863889 with a standard deviation of 8114305019. The minimum FDI is -6759100000 while the maximum FDI is 21136200000.

Interest rates

The interest rate is the value of borrowing money or credit in the country. Interest rates have been established to have a positive correlation with the exchange rates. For example, an increase in interest rates makes the cost of loans to be higher. A decrease in interest rates makes the cost of loans to be cheaper. Therefore, interest rates and exchange rates have a direct linear relationship.

When interest rates are high in the economy, the number of investors seeking to invest in the economy increases due to the expected higher returns. Similarly, when interest rates are low, the number of investors seeking to invest in the economy decreases. An increase in the number of investors and investments increases the demand for the local currency while a decrease in the number of investors and investments reduces the demand for the local currency. The reduction in the demand for the local currency leads to a decrease in the value of the currency and a decline in the exchange rate. An increase in the demand for the local currency leads to an increase in the value of the local currency and an increase in the exchange rate for the currency (Keynes 218). The table below shows the descriptive statistics for interest rates.

Interest rates

Mean

8.756528

Standard Error

0.557589

Median

8.711667

Standard Deviation

3.345533

Sample Variance

11.19259

Kurtosis

1.336044

Skewness

1.011302

Range

14.46667

Minimum

3.533333

Maximum

18

Sum

315.235

Count

36

The average interest rate is 8.7565% with a standard deviation of 3.35. The minimum interest rate is 3.53% while the maximum interest rate is 18%.

Regression analysis

This study will use regression analysis to determine the effect of GDP on dollar exchange rate for Korean Won. First, a correlation analysis will be carried out to determine the linearity between the dependent variable and independent variables. The table below shows the correlation matrix.

Exchange rate

GDP (Korea)

GDP (US)

Imports

Exports

FDI

Interest rates

Exchange rate

1

GDP (Korea)

0.719013

1

GDP (US)

0.760059

0.990569

1

Imports

0.634579

0.981097

0.953

1

Exports

0.62914

0.961054

0.928139

0.99362

1

FDI

0.217644

0.674058

0.583938

0.77767

0.800125

1

Interest rates

-0.52146

-0.81153

-0.80273

-0.78507

-0.76219

-0.51276

1

The correlation between the dependent variable and the independent variables is highest with the US GDP and lowest with FDI. The independent variables have a medium to strong correlation with the dependent variables except for the FDI.

One of the assumptions of the regression analysis is that there is no multicollinearity in the data. However, the data used in the study is likely to have multicollinearity. This is evident from the high values of the correlation coefficient for the relationship between the independent variables.

The regression analysis is carried out using the stepwise regression method. First, all the six independent variables are included in the model. The independent variables are then removed from the model using the backward regression method. Each non-significant predictor is withdrawn from the model. The order of removing the predictors is determined by the p-value of the predictor.

Empirical results

A multiple regression analysis is conducted using the exchange rate as the dependent variable and the six other variables as the predictor variables. The multiple regression equation obtained from the regression analysis is significant. However, some variables are insignificant. US GDP, FDI and interest rates are the insignificant variables in the first regression model obtained. The US GDP has the highest value of p-value for the significance of the predictor. Therefore, US GDP is dropped.

In the second regression analysis, a significant regression model is obtained. However, FDI and interest rates are not significant because the p-values are greater than the level of significance, 5%. FDI has the highest value of p-value. Therefore, FDI is dropped from the model.

Lastly, the third regression analysis yields a significant multiple regression model. The coefficient for interest rates is insignificant because the p-value is greater than the level of significance, 5%. Therefore, interest rate is dropped from the model.

The final model obtained contains three independent variables; Korean GDP, imports, and exports. The table below shows the results of the regression analysis.

Coefficients

Standard Error

t Stat

P-value

Lower 95%

Upper 95%

Intercept

414.136758

59.99286475

6.9031

8.17523E-08

291.9352915

536.3382246

GDP (Korea)

2.5198E-09

3.12403E-10

8.065859

3.28585E-09

1.88346E-09

3.15615E-09

Imports

-8.40291E-09

1.35671E-09

-6.19359

6.20475E-07

-1.11664E-08

-5.63938E-09

Exports

4.08137E-09

8.2081E-10

4.972373

2.15328E-05

2.40944E-09

5.75331E-09

We can obtain the following multiple regression equation for estimating the exchange rate for the Korean won against the US dollar.

Exchange rate = 414.1368 + 2.5198E-09(GDP Korea) – 8.4029E-09(Imports) + 4.0814E-09(Exports)

Interpretation

The coefficient of the Korean GDP implies that when the value of GDP increases by I billion dollars in Korea, the value of the exchange rate increases by 2.5198. The coefficient of Imports implies that when the Korean imports increase by 1 billion dollars, the exchange rate reduces by 8.4029 units. Lastly, the coefficient of exports implies that when the Korean exports increase by 1 billion dollars, the exchange rate increases by 4.0814.

The table below shows the analysis of variance for the significance of the regression model.

ANOVA

df

SS

MS

F

Significance F

Regression

3

1257451.933

419150.6

43.51115095

2.12467E-11

Residual

32

308261.683

9633.178

Total

35

1565713.616

The multiple regression model is a significant predictor of the dependent variable because the p-value, 2.1247E-11 is lower than the level of significance.

The table below shows the results f the correlations analysis for the regression model.

Regression Statistics

Multiple R

0.896168206

R Square

0.803117454

Adjusted R Square

0.784659715

Standard Error

98.14875238

Observations

36

The multiple coefficient of determination, r2 is 0.8031. This implies that 80.31% of the variation in the dependent variable is attributed to the effect of the independent variables used in the model.

Summary and Conclusion

The impact of the independent variables on the dependent variable can be determined by the behavior of the dependent variable. An increase in the exchange rate indicates a weakening of the Korean won against the US dollar. A decrease in the exchange rate indicates an increase in the relative value of the won to the US dollar.

From the regression equation, Korean GDP and exports have positive coefficients. The coefficient for the variable, imports, is negative. This implies that an increase in the value of Korean GDP and exports would weaken the country’s currency by increasing the exchange rate. Further, the regression equation implies that an increase in exports would strengthen the currency by reducing the exchange rate.

The results of the regression analysis have contrary to the expectations. It would be important to carry out further research to evaluate the cause of the divergence of the study results from the expectations.

Works Cited

Colander, David C. Economics. 9th. New York: McGraw-Hill Irwin, 2013.

Gregory, Mankiw and P Taylor Mark. Macroeconomics. New York: Worth Publishers, 2014. Print.

Keynes, J. M. General Theory of Employment, Interest, and Money. New Delhi: Atlantic Publishers & DistributorsPvt Ltd, 2007.

Murali, Iyengar. Money matters: macroeconomics and financial markets. Thousand Oaks, Calif.: SAGE Publications, 2011.