It is important for policymakers to interpret movements in a currency's exchange rate and assess its over- or under-valuation. It is argued that the Korean Won had been overvalued just before its currency crisis in 1997. This paper assesses whether Korea experienced real appreciation in the 1990s. To do this, it estimates real exchange rates determined by underlying economic fundamentals.

Before estimating Equilibrium Real Exchange Rates, I calculate Real Effective Exchange Rates using 16 trade partners' trade weights. Then I derive the reduced forms implied by a theoretical model, along the lines of Edwards(1994). The ERER is defined as the level consistent with simultaneous internal and external balances.

The long-run ERER is estimated by a cointegrating relationship, especially with the Fully Modified Estimation Method proposed by Phillips and Hansen(1990). In addition, an Error Correction Model is specified to estimate the actual Real Exchange Rates.

I find from the ERER estimates that actual Real Exchange Rates did not  deviate much from the equilibrium level. The misalignment reached less than 9% just before the currency crisis. Moreover, capital inflows turn out to have had the biggest impact on the ERER. Capital Market Liberalization induced a huge capital inflow, resulting in real appreciation even with large current account deficits since TOT deterioration started in 1995.