BoK: "Accommodative Monetary Policy, Limited Real Economy Impact During COVID-19"

Monetary Policy Easing Stance... Defending Excessive Real Economy Contraction
Preventing Negative Feedback: Real Economy Deterioration → Financial Instability → Further Real Economy Deterioration

[Asia Economy Reporter Jang Sehee] There is a forecast that the effect of accommodative monetary policy spreading to the real economy will be limited. This is because the novel coronavirus infection (COVID-19) suppresses demand and supply and increases economic uncertainty.

According to the 'December 2020 Monetary and Credit Policy Report' approved by the Bank of Korea on the 10th, the Bank of Korea's analysis using macroeconomic models showed that a 0.25 percentage point cut in the base interest rate would have an impact on the gross domestic product (GDP) of +0.06% in the first year and +0.08% in the second year. The impact on consumer prices is estimated at +0.03% in the first year and +0.04% in the second year.

The Bank of Korea explained, "It is necessary to note that the transmission effect of monetary policy is being constrained due to uncertainties caused by COVID-19 and the increase in household debt."

However, it stated that social distancing and the tendency to refrain from outdoor activities due to COVID-19 act as factors that suppress consumption.

Although monetary policy appears to have exerted a positive effect on the real economy, it is necessary to be aware that increased uncertainty from COVID-19 and rising household debt are limiting the transmission effect of monetary policy on the real economy.

Consumption contraction has also led to a significant decrease in corporate sales, and the uncertain economic situation caused by COVID-19 is likely to negatively affect corporate investment decision-making. In fact, corporate sales in the second quarter of this year were found to have decreased by 10.1% compared to the same period last year.

Since the spread of COVID-19, accommodative monetary policy such as base rate cuts has prevented excessive contraction of the real economy. The Bank of Korea explained that market interest rates and financial institution lending and deposit rates have fallen significantly following the base rate cuts.

Private credit has expanded significantly in both household and corporate loans, and stock prices sharply declined immediately after the COVID-19 outbreak but quickly rebounded, according to the analysis. The corporate sector is analyzed to have improved funding conditions and eased interest repayment burdens. In the household sector, interest repayment burdens of debt-holding households, especially among low-income groups, are expected to be alleviated due to the interest rate decline.

The Bank of Korea stated, "Monetary easing has substantially mitigated the negative effects that financial tightening caused by the COVID-19 shock could have on the real economy," adding, "It prevented negative feedback from financial instability leading to further deterioration of the real economy and reduced the possibility of tail risk occurrence in the macroeconomy."

Meanwhile, if the financial condition index had not improved from the lowest level in April after COVID-19 and remained at the same level, the negative gap rate of GDP would have expanded more than in reality.

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