70th Anniversary of Bank of Korea Challenges... 'Interest Rate Recovery, Low Inflation, Digital Currency'

Discussion on Ending 0% Interest Rate
2% Inflation Target Hard to Achieve... Need for 'Deflation Fighter' Role
China's CBDC Hegemony War... Bank of Korea to Start Experimental Operation Next Year

[Asia Economy Reporter Kim Eunbyeol] The Bank of Korea will mark its 70th anniversary on the 12th. This year, amid an unprecedented economic crisis caused by the novel coronavirus disease (COVID-19), the significance of the 70th anniversary inevitably feels greater not only to the Bank of Korea’s executives and staff but also to economic experts. Since the Bank of Korea has mobilized almost all possible monetary and credit policies under relevant laws to respond to the COVID-19 impact, there is growing interest in what challenges the Bank will face over the next decade.

◆ When will the 'post-COVID' policy return? = As of the 8th, the Bank of Korea’s base interest rate stands at 0.50% per annum, the lowest level ever. There is some room to lower the rate once more, but it is practically close to zero. This year, the Bank of Korea has also mobilized various policies, including financial intermediary support loans, unlimited repurchase agreement (RP) purchases on a full supply basis, simple purchases of government bonds, and the establishment of a special purpose vehicle (SPV) for purchasing corporate bonds and commercial paper (CP).

The issue lies in the post-COVID-19 period. If the economic situation improves over the next ten years, discussions about the timing to raise the base interest rate again will inevitably arise. Even after the financial crisis, the Bank of Korea was criticized for 'not raising interest rates sufficiently and timely.' A senior Bank of Korea official said, "In April, many members of the Bank’s Monetary Policy Committee were replaced, and their tendencies will only be confirmed after COVID-19. While it is difficult to oppose easing policies now, when the time comes to return interest rates to previous levels and implement tightening policies, there may be differing judgments about the economy."

There is also criticism that if the global zero interest rate policy lasts longer than expected, the Bank of Korea will need to reconsider the role of its monetary policy itself. The U.S. Federal Reserve (Fed) may maintain zero (0.00?0.25%) interest rates longer than expected, and even the possibility of introducing negative interest rates has emerged. In such a case, the Bank of Korea would need to deploy other tools such as yield curve control (YCC) and forward guidance instead of relying on the base interest rate.

◆ Monetary policy challenges in an era of low inflation = Due to the global trend of low growth and low inflation, concerns about the monetary policy goal of 'price stability' are bound to increase. The Bank of Korea Act Article 1 stipulates that the Bank should promote price stability and pay attention to financial stability. Currently, the Bank targets an annual consumer price inflation rate of 2%, but this year’s inflation is forecasted at 0.3%, far below the target. Due to demographic changes and the Fourth Industrial Revolution, it is pointed out that achieving 2% inflation will remain difficult, and recently, alternative monetary policies have been discussed mainly in academia. Alternatives include price-level targeting, nominal GDP targeting, and average inflation targeting.

Jang Min, Senior Research Fellow at the Korea Institute of Finance, said, "In the short term, a sharp deterioration in economic and employment conditions could lead to deflation, and in the mid-to-long term, factors such as a declining working-age population and asset price instability persist. There is a growing recognition that the Bank of Korea needs to shift its role to a 'deflation fighter.'" However, it is not easy for the Bank of Korea to lead in introducing new policies ahead of major advanced countries. Jang added, "While it may be difficult to be the first to adopt new policies, it is worth considering adding other goals suited to Korea’s circumstances, such as employment stability, in addition to price stability."

◆ Introduction of Central Bank Digital Currency (CBDC) = CBDC, which central banks worldwide are rushing to adopt, led by China, is also a challenge for the Bank of Korea. The Bank plans to review technical and legal requirements for CBDC introduction within this year and conduct pilot testing next year. Initially, the Bank maintained that the need for CBDC issuance was not significant, but recently, with the increase in non-face-to-face payments due to COVID-19, research has accelerated. Amending the Bank of Korea Act will also be necessary to introduce CBDC.

Although the Bank of Korea considers the CBDC introduction timeline to be distant, it is focusing on maximizing benefits and minimizing side effects upon introduction. Yoo Hee-jun, Head of the Digital Currency Technology Team at the Bank’s Financial Settlement Department, said, "Since there could be side effects such as the emergence of marginalized groups, even if CBDC is introduced, it will be done very gradually."

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