[Q&A] Lee Ju-yeol "Concerns Over Housing Prices... Considering Alternatives to Inflation Targeting"

Bank of Korea 'Price Stability Target Operation Status Review Report' Press Conference

[Asia Economy Reporter Kim Eunbyeol] Lee Ju-yeol, Governor of the Bank of Korea, reiterated his intention to explore an alternative monetary policy framework that can overcome the limitations of the inflation targeting system in a low inflation environment. Governor Lee stated at a press conference following the release of the 'Inflation Targeting Operation Status Review Report' on the 25th, "While there is abundant theoretical discussion about policy frameworks to replace the inflation targeting system, no consensus has yet been formed on concrete solutions."

In response to the low growth and low inflation trend, major central banks have operated policy interest rates at low levels, and especially after the spread of COVID-19, monetary policy has been conducted expansively, with major countries' benchmark interest rates approaching the effective lower bound. Accordingly, global discussions continue on whether it is appropriate to maintain the current inflation targeting system, which focuses on curbing inflation, even in a low inflation environment.

He said, "Since there is no suitable alternative, major central banks have maintained the current inflation targeting system while developing and using various policy tools such as quantitative easing (QE), negative interest rates, yield curve control (YCC), and forward guidance to enhance the effectiveness of monetary policy." He added, "These policy tools were previously considered unconventional, but as the global economy has experienced prolonged low growth and low inflation, they are gradually being accepted as general tools. The Bank of Korea will also seek an alternative monetary policy framework by referring to international discussions."

The following is a Q&A with Governor Lee.

- Among alternative options such as price level targeting and average inflation targeting, which approach is suitable for Korea?

▲ Price level targeting is a scheme that aims at an absolute level, while average inflation targeting is a concept that achieves the average inflation rate over a certain period. The advantage of both alternatives is that economic agents' inflation expectations are strongly anchored to the target. However, both systems have the drawback that if the price level deviates from the target at any point due to unexpected shocks, a rapid policy change is required to revert it, which can undermine monetary policy stability and affect the real economy, potentially amplifying economic fluctuations. For now, we will focus on supplementing the shortcomings of the current inflation targeting system and continue to participate in international discussions to steadily seek a monetary policy framework that can replace the inflation targeting system.

- There are criticisms that relatively high real interest rates are suppressing consumption and investment. What is your view on the argument that more accommodative monetary policy should be used to lower real interest rates?

▲ Whether to further ease will be carefully judged by closely monitoring the development of COVID-19, its impact on domestic and international financial and economic conditions, and changes in financial stability. While the real policy rate is certainly a reference indicator, it is appropriate to comprehensively consider various indicators such as market liquidity conditions when making judgments. It should be noted that recent market liquidity has been rapidly increasing based on private credit growth. Since economic conditions differ by country, comparing the absolute level of real interest rates across countries to evaluate the appropriateness of monetary policy is not very meaningful. Korea's current real interest rate ranges from slightly above 0% to slightly below -1%, which is considered a level that does not constrain the real economy.

- There are concerns that accommodative monetary policy aimed at supporting economic recovery is not leading to investment and consumption but only causing asset price increases such as stocks and real estate. What is your view on this?

▲ We assess that the accommodative monetary policy maintained so far has achieved the intended effects. However, under this accommodative stance, housing prices, which had shown signs of stabilization, are showing upward trends again, which we view with concern. Nevertheless, considering the recent economic and inflation situation, it is inevitable to operate monetary policy accommodatively, and we believe it is better to address risks of financial market imbalances, including asset prices, through consistent macroprudential policies. Since the government has a strong commitment to stabilizing the real estate market, we will carefully monitor the effects of policies and subsequent market movements.

- Do you think large-scale liquidity could increase inflationary pressures?

▲ During the 2008 global financial crisis, major countries such as the US and Eurozone implemented large-scale quantitative easing, but inflationary pressures were not significant because most of the excess reserves remained within the financial sector. In contrast, during the COVID-19 response, a substantial amount of liquidity was directly supplied to the private sector. As economic activities fully resume and demand rapidly recovers, if the expanded liquidity is not actively withdrawn, it is true that inflationary pressures could arise. However, even after COVID-19 subsides, economic structures and agents' behaviors will change. Debt has increased, and saving incentives have expanded, so demand recovery is expected to be slow. Moreover, the rapid expansion of online transactions and acceleration of corporate automation and unmanned operations exert a suppressive effect on inflationary pressures. Therefore, although liquidity alone would exert upward pressure, other factors act to restrain it, so the low inflation trend is expected to continue for a considerable period even after COVID-19 subsides.

- The recent low inflation trend is described as 'disinflation' rather than 'deflation.' Does this mean that a certain degree of low inflation can continue without major problems?

▲ The sharp slowdown in consumer price inflation after the spread of COVID-19 was largely due to weakened demand-side inflationary pressures from economic slowdown and supply-side factors such as the decline in international oil prices. The possibility of deflation, meaning a continuous decline in prices across goods and services, is considered low. However, if economic recovery is significantly delayed or low inflation persists longer than expected, it could affect general economic agents' inflation expectations and the trend inflation path, so caution is warranted. We are closely monitoring medium- to long-term inflation expectations and trend inflation flows.

- The International Monetary Fund (IMF) lowered its growth forecast again the day before. It seems necessary to consider the possibility of the worst-case scenario among the Bank of Korea's initial forecasts becoming a reality.

▲ At this point, we believe the global spread of COVID-19 is subsiding later than we initially expected. We originally thought economic activities would resume once the spread subsided, but although the spread has not eased, economic activities are gradually and sequentially resuming, showing a decoupling pattern. Therefore, we cautiously judge that this does not significantly deviate from the baseline scenario. The IMF lowered its forecast assuming prolonged social distancing, but we feel that the shock may have been somewhat overestimated. Comparing the current situation with the forecast made a month ago, we do not see significant changes that would require revising the forecast. Of course, this depends heavily on the development of COVID-19, so the forecast for this year may change accordingly, but based on the past month's developments, there is no clear reason to alter last month's forecast significantly.

- There are claims that the Bank of Korea should secure exclusive inspection rights and establish a deputy governor position responsible for financial stability to effectively carry out policy objectives. What is your opinion?

▲ It is true that expanding policy tools is necessary to efficiently fulfill financial stability responsibilities. However, specific details require consultation among related agencies and legal amendments, so I believe these matters should be discussed over time.

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