KDI "Bank of Korea Should Cut Base Rate Close to 0%... Government Bond Purchases Also Needed"

KDI Announces Economic Outlook and Issue Analysis for First Half of 2020
"Possibility of Market Liquidity Absorption When Issuing Government Bonds... Bank of Korea Should Absorb Some"

[Sejong=Asia Economy Reporter Kim Hyunjung] The Korea Development Institute (KDI) stated that in response to the novel coronavirus disease (COVID-19) crisis, the Bank of Korea's interest rate cuts should be implemented "as quickly as possible" and "to a level sufficiently close to 0%." It also diagnosed that since the government is likely to absorb market liquidity by issuing government bonds in the future, the Bank of Korea should purchase these bonds to facilitate liquidity supply to businesses and households.

KDI, a government-funded research institute under the Ministry of Economy and Finance, published the "KDI Economic Outlook (First Half of 2020)" report on the 20th, stating that in response to the economic downturn and unavoidable downward pressure caused by COVID-19, the Bank of Korea needs to lower the base interest rate as much as possible at the earliest possible time and employ unconventional monetary policy tools such as purchasing government bonds. It explained that active monetary policy management is urgently required as economic growth rapidly contracts and the consumer price inflation rate falls to around 0%.

The report suggested, "Interest rate cuts should be prioritized because they indiscriminately affect a wide range of economic agents and have a greater ripple effect compared to unconventional monetary policies," and added, "Since there is a high possibility of government bond issuance due to increased fiscal spending, monetary authorities need to respond to the current crisis with a policy mix that partially absorbs government bond supply to ensure sufficient liquidity in the private sector."

Furthermore, it viewed that normalization of monetary policy is desirable only after inflation has stably risen to the price stability target level (2%). KDI diagnosed, "Since 2013, the inflation rate has consistently fallen below the monetary policy price stability target, and the core inflation rate has been on a downward trend, remaining in the 0% range since March 2019," adding, "Prolonged low inflation leads to a decline in expected inflation, which can constrain the downward adjustment of the real interest rate (base rate minus expected inflation) through interest rate cuts." It further stated, "Even if inflation rebounds somewhat due to future economic recovery or rises in agricultural products and international oil prices, patience is required in normalizing monetary policy until the inflation rate sufficiently stabilizes at the target level."

Jung Kyu-cheol, head of the KDI Economic Outlook Office, commented, "Since monetary policy prioritizes macroeconomic stability, tools that can supply liquidity to a broader range of people and economic agents should be prioritized," and added, "I believe that is the interest rate cut."

Regarding the Bank of Korea's government bond purchases, Director Jung evaluated, "Government bonds released into the market will absorb a significant portion of market liquidity," and said, "If the Bank of Korea can purchase some of these bonds in response, the liquidity constraints can be substantially alleviated." He also added, "Currently, if liquidity shortages cause businesses or households to go bankrupt, economic recovery could be further delayed, so it is necessary to facilitate smooth liquidity supply."

Meanwhile, the Bank of Korea is scheduled to hold a Monetary Policy Committee meeting on the 28th to decide the base interest rate. After implementing a 'big cut' by lowering the base rate by 0.5 percentage points at an emergency meeting in March, the rate was held steady at 0.75% in April.

This content was produced with the assistance of AI translation services.