Bank of Korea Studying 'Beyond the Benchmark Interest Rate'

The Bank of Korea Holds Base Rate at 0.50% Near Effective Lower Bound
Considering Long-Term Government Bond Yield Targeting and Measures to Overcome Low Inflation

[Asia Economy Reporter Kim Eunbyeol] Although the Bank of Korea's Monetary Policy Committee decided to keep the base interest rate unchanged on the 16th, concerns about future monetary policy are deepening. This is because the base rate has dropped to 0.50% per annum, approaching the effective lower bound, which is the floor for lowering interest rates.

Lee Ju-yeol, Governor of the Bank of Korea, after freezing the base rate at a historic low during the July Monetary Policy Committee meeting, stated at a briefing, "We believe the base rate is close to the effective lower bound," adding, "If the domestic economic downturn worsens and additional monetary easing is deemed necessary, we will respond by appropriately utilizing various policy tools beyond interest rates, such as lending or open market operations."

The outlook that the novel coronavirus disease (COVID-19) crisis will last longer than expected is gaining traction. Since confirmed COVID-19 cases continue to emerge in the U.S. and other countries, the global consensus is that a 'V-shaped recovery' is unlikely, and given the shortage of 'ammunition' in monetary policy, further research is needed.

Recently, the Bank of Korea's Economic Research Institute and overseas offices have been focusing on analyzing central bank policies and their effects beyond interest rates using international academic information. A senior official at the Bank of Korea said, "There is currently no plan to apply policies other than adjusting the base rate," but added, "Since it is uncertain when and what new policies the U.S. Federal Reserve (Fed) will introduce, we are continuously studying trends to keep up."

Lee Ju-yeol, Governor of the Bank of Korea, is speaking at the Monetary Policy Direction press conference held on the 16th at the Bank of Korea in Jung-gu, Seoul.

① Setting a Target for Long-term Government Bond Yields?

This is a monetary policy that has recently attracted significant attention from central banks. It involves setting a target for long-term government bond yields and purchasing bonds sufficiently whenever yields rise above that target to lower interest rates. This is also known as the 'Yield Curve Control (YCC)' policy. The Bank of Korea's Economic Research Institute recently focused on an analysis by the New York Federal Reserve regarding the effects of Japan's YCC.

The Bank of Japan (BOJ) sets the 10-year government bond yield between 0% and 0.1%. According to the New York Fed's analysis, the effects of YCC are clearly observed in financial markets. It was also analyzed as a policy effect that the unemployment rate remained historically low until before COVID-19 after YCC implementation. However, the fact that core consumer prices still hover around 0.5% was noted as a shortcoming.

② Considering Alternatives to Overcome Low Inflation

Measures to overcome the low inflation trend, where the inflation rate is significantly below the inflation target (2%), are also under consideration. The Economic Research Institute has shown interest in analyses of alternatives to the inflation targeting system recently proposed by the San Francisco Fed and the Bank of Canada. In particular, it highlighted that the average inflation targeting system is effective when demand shocks occur and that monetary policy should target the average inflation over approximately 2 to 6 quarters.

The average inflation targeting system allows inflation to exceed 2% during economic growth periods, considering the low inflation trend during recessions. Instead, it aims to achieve an average inflation rate over a certain period. Governor Lee mentioned at last month's briefing on the 'Inflation Targeting Operation Status Report' that "(the advantage of such) alternatives is that economic agents' inflation expectations become strongly anchored to the target." However, he pointed out that a rapid policy shift is required to revert inflation levels when they deviate from the target, which could exacerbate economic fluctuations.

③ What is the Appropriate Level of Dependence on Fiscal Policy?

This concern is shared not only by the Bank of Korea but also by central banks and governments worldwide. As the COVID-19 pandemic prolongs and central banks have largely exhausted their response measures, the share of fiscal policy in future crisis responses may increase significantly compared to monetary policy. The Bank of Korea's Washington representative summarized remarks made by Fed Governor Lael Brainard at the National Association for Business Economics (NABE) online event.

Governor Brainard stated, "The economic outlook is highly uncertain due to the impact of COVID-19, and future economic recovery will mainly depend on fiscal policy," prompting consideration of the Fed's potential reliance on fiscal policy.

The Washington representative added, "Governor Brainard is reportedly among the candidates that Democratic presidential nominee Joe Biden might nominate as the next Fed Chair," and noted, "Although she is known to have significant influence within the Fed, she does not frequently speak in public forums."

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