Major macroeconomic variables generally fluctuate around the long-term
economic growth trend, depending for example upon changes in economic
conditions and the incidence of various shocks. Volatility of this type widens at
times and narrows at other times depending upon changes in economic conditions
and the characteristics of economic shocks. In Korea, consumption volatility
increased significantly in the period just before and after the Asian Currency
Crisis. During these periods there emerged a consumption volatility puzzle, in
which consumption volatility exceeded GDP volatility. However, consumption
volatility has gradually decreased since then and so far another consumption
volatility puzzle has not taken shape.

  From the perspective of traditional macroeconomic theory, a consumption
volatility puzzle is a very extraordinary phenomenon. For a rational consumer
whose decisions are made based on the permanent income hypothesis, there exist
incentives for consumption smoothing for lifetime utility maximization, in response
to income changes by period. In addition, compared with other categories of
expenditure such as investment, consumption, which amounts to half of GDP,
generally moves more stably and its volatility remains less than income volatility.
In this paper, we examine through the analysis of models based on recent
macroeconomic theories what caused the consumption volatility puzzles to arise in
a concentrated form during the periods just before and after the Asian Currency
Crisis but not at the time of the Global Financial Crisis. In addition, the trend of
consumption volatility since 2000 is analyzed, by reflecting other economic
conditions such as Korean asset price trend.

  First, according to our analysis using a productivity shock model, productivity
shocks during the Asian Currency Crisis are assessed as having had greater
permanence than those during the Global Financial Crisis. Households, the agents
of consumption, are seen to have responded more sensitively to productivity
shocks resulting from the eruption of a crisis and to a consequent decrease in
income during the Asian Currency Crisis. Meanwhile, Korea’s real interest rate
rose greatly during the Asian Currency Crisis, with risk premiums increasing in
line chiefly with a rise in default risks, whereas they rose only slightly during the
Global Financial Crisis.

  This implies that changes in the real interest rate during the Asian Currency
Crisis had a great influence on the intertemporal choices of households in terms
of consumption and savings. The characteristics of permanent productivity shocks
or changes in the real interest rate differed between the two crisis periods,
because, whereas the Global Financial Crisis broke out in the US and other parts
of the external sector, the Asian Currency Crisis was caused by the vulnerability
of the domestic banking sector and had highly negative influences on the real
economy in terms of consumption, investment and the like in the course of the
restructuring of the financial and corporate sectors.
  Meanwhile, apart from these two crisis periods, consumption temporarily rose at
a faster pace than income in the early 2000s, which seems to have been
influenced by a sharp run-up in real estate prices at the time. This means that
sudden changes in real estate prices caused households to intuitively change their
expected permanent income (capital gains), and borrowing conditions, thus inducing
higher levels of volatility than actual income volatility. In addition, consumption
volatility has subsided significantly up until the present day since the Global
Financial Crisis, and consumption volatility has declined, in a movement that has
centered on older age groups. This is analyzed as being partially due to the
increased supply of labor by members of this age group and their consequently
increased wage income.

  According to the results of analysis based on the recent theory, the economic
shocks the Korean economy faced due to the two crisis periods differed. However,
in order to discuss the fundamental differences between these shocks, there is a
need for additional research on the fundamental frictions in the economy
represented by the external shocks suggested by the theory. Specifically, there is
a need for a greater in-depth understanding of the structural factors within and
without the economy which influence a sudden fall in the growth trend or
changes in risk premium volatility. Furthermore, it is also necessary to make policy
efforts to facilitate the securitization of property assets, in order to mitigate
households’ exposure to changes in real estate prices.