KDI: "Korea Does Not Need to Raise Interest Rates Following the US... Low Risk of Capital Outflow"

Report on US Interest Rate Hikes and South Korea's Policy Response

Deputy Prime Minister and Minister of Economy and Finance Choo Kyung-ho and Bank of Korea Governor Lee Chang-yong shake hands at their first breakfast meeting held on the 16th at the Press Center in Jung-gu, Seoul. Photo by Hyunmin Kim kimhyun81@

[Asia Economy Sejong=Reporter Kwon Haeyoung] As the United States embarks on steep monetary tightening, there are calls for South Korea to operate an independent monetary policy based on inflation and economic conditions rather than sharply raising interest rates in tandem with the US.

On the 16th, the Korea Development Institute (KDI) stated in its report titled "US Interest Rate Hikes and South Korea's Policy Response" that "If the base interest rate is raised following the US, the economic slowdown will directly impact our economy, whereas conducting an independent monetary policy will have little effect aside from temporary inflation increases."

The US consumer price inflation rate stood at 8.3% as of last month, rising much faster than South Korea's 4.8%. While South Korea also needs to raise rates to stabilize prices, KDI pointed out that the pace of hikes should be adjusted considering the differences in inflation and economic conditions between the two countries.

KDI emphasized, "It is necessary to tolerate the base interest rate gap that may arise due to differences in inflation and economic conditions between the US and South Korea," adding, "The steep rate hikes similar to those in the US, where inflation is higher and economic recovery is stronger, are not required for our economy."

KDI also forecasted that the possibility of capital outflows would be low if South Korea's interest rates remain lower than those of the US. "Since the 2000s, there has been no large-scale capital outflow caused by interest rate gaps between South Korea and the US," KDI said, noting that "South Korea's external soundness is currently evaluated as relatively good, so the likelihood of sudden capital outflows is low." It highlighted that during periods when the US base rate was higher than South Korea's?June 1999 to February 2001, August 2005 to August 2007, and March 2018 to February 2020?there were no large-scale capital outflows or foreign exchange market strains.

Regarding the recent sharp rise in the won-dollar exchange rate, KDI argued for refraining from foreign exchange market intervention and suggested considering the establishment of a currency swap agreement with the US.

KDI analyzed, "Considering that exchange rate fluctuations serve as a mechanism to adjust imbalances between countries and absorb external shocks, it is necessary to tolerate exchange rate fluctuations in line with the purpose of the free-floating exchange rate system and refrain from intervening in the foreign exchange market." It added, "As experienced during the global financial crisis and the COVID-19 crisis, when international financial markets become highly unstable, establishing currency swap agreements with countries like the US can be an effective response measure." Furthermore, it stressed, "Maintaining macroprudential soundness is a key factor in withstanding external shocks," and emphasized the need to continue the policy of strengthening macroprudential soundness during the recovery phase from the COVID-19 crisis for the time being.

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