The Bank of Korea: "Concerns Over Private Debt and Reduced Economic Resilience... Must Consider Fiscal Capacity When Assessing"

BOK Issue Note

[Sejong=Asia Economy Reporter Son Sun-hee] Amid the rapid increase in private household debt during the COVID-19 pandemic, concerns have been raised that if this trend continues, it could undermine economic responsiveness. Since private debt and government debt interact and affect the economy, it has been pointed out that the scale of private debt should also be considered when assessing future fiscal capacity.

On the 13th, the Bank of Korea (BOK) published a BOK Issue Note titled "Characteristics of Changes in Macro Leverage and Macroeconomic Impacts," which includes these points. This report was prepared to analyze and evaluate the macroeconomic ripple effects, noting that not only government debt increased due to expansionary fiscal policies in response to the recent COVID-19 crisis, but private debt also surged sharply.

The BOK analyzed recent trends in total debt (macro leverage), which combines household, corporate, and government debt in Korea. Park Chang-hyun, Deputy Head of the BOK Research Department’s Survey Team, explained, "Both private and government leverage ratios have risen simultaneously, and unlike major countries, the private sector is leading the leveraging." He added, "After the COVID crisis, government sector leverage increased significantly in major countries, but in Korea, household debt increased relatively quickly." He further noted, "Debt among vulnerable groups such as low-income and young people has increased relatively rapidly."

While many countries, including the United States and other advanced economies, increased government debt by injecting money to respond to the COVID-19 crisis, Korea is unique in that household debt also rose sharply alongside government debt.

In such a situation where debt levels are high across all economic sectors, including households and government, the BOK explains that the downside risks to the real and financial economy are likely to expand, intensifying negative macroeconomic impacts. The report stated, "If the private sector undergoes deleveraging (debt reduction) when private leverage is high and fiscal capacity is limited, economic shocks will be greater and recovery will take longer."

Analysis of household debt reduction periods in 42 major countries since the 2000s shows that typically, after about 3 to 4 years of debt growth, debt reduction policies were implemented, which tended to last for 2 to 3 years. Additionally, about 23% of these debt reduction periods were accompanied by declines in housing prices.

In Korea’s case, household debt increased for 16 years after debt reduction was implemented in the early 2000s, which the BOK analyzed as a very unusual phenomenon globally.

Deputy Head Park expressed concern, saying, "Leverage can help ease liquidity constraints for households and businesses in the short term, supporting flexible economic activities. However, if the recent sharp increase in leverage continues, it could lead to greater domestic economic volatility, undermine macro-financial stability, and reduce policy capacity and private spending power, thereby weakening economic responsiveness."

He emphasized, "Since debt growth exceeding the growth rate inevitably expands leverage, it is necessary to guide debt changes to be balanced with growth and gradually adjust the accumulated leverage. When assessing fiscal capacity, the size of private debt should also be taken into account."

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