Lee Chang-yong "Korean Big Step = US Giant Step... Monetary Policy Harder with Exchange Rate"

Lecture on 'Korean Monetary Policy' at Peterson Institute for International Economics
Expressing Difficulties in 'Forward Guidance' Communication

Lee Chang-yong, Governor of the Bank of Korea, is explaining the base interest rate hike at a press conference held at the Bank of Korea in Jung-gu, Seoul, on the morning of the 12th. Photo by Joint Press Corps

[Asia Economy Reporter Seo So-jeong] As the Bank of Korea (BOK) took its second big step this month by raising the base interest rate by 0.50 percentage points, Lee Chang-yong, Governor of the Bank of Korea, emphasized that Korea's 0.50 percentage point rate hike is comparable to the U.S.'s 0.75 percentage point increase. He also expressed that the rapid depreciation of the exchange rate is making Korea's monetary policy decisions more complicated, and that due to the characteristics of a small open economy, it is not easy to implement forward guidance.

On the 15th (local time), Governor Lee gave a lecture titled "Strengthening Global Monetary Policy Tightening and Korea's Monetary Policy" at the Peterson Institute for International Economics, stating, "Considering that the proportion of variable-rate loans in mortgage loans is less than 10% in the U.S. but well over 60% in Korea, it is reasonable to think that Korea's 0.50 percentage point rate hike is comparable to the U.S.'s 0.75 percentage point increase." Governor Lee is currently visiting the U.S. to attend the International Monetary Fund (IMF) - World Bank Group (WBG) Joint Annual Meetings.

Governor Lee also explained in detail the reasons for revising the previous forward guidance of gradual 0.25 percentage point increases and implementing the second big step. He said, "Since August, global financial markets have experienced significant volatility, forcing the Bank of Korea to inevitably reconsider its existing monetary policy path. The dot plot of the U.S. Federal Reserve (Fed) in September showed that the year-end interest rate was more than 0.50 percentage points higher than what the Bank of Korea had anticipated in July and August, which significantly increased volatility in global financial markets."

He cited the recent sharp rise in the won-dollar exchange rate as a major reason for the big step. Governor Lee said, "Along with the Fed's rapid rate hikes, the Japanese yen and Chinese yuan, which are exceptionally maintaining accommodative monetary policies among major central banks, have depreciated significantly, accelerating the depreciation of the Korean won since September. Additionally, unexpected fiscal policy announcements in the U.K. have heightened volatility in the foreign exchange market due to instability in international financial markets."

Due to the semiconductor cycle, Korea's trade balance has decreased, and the won has faced additional pressure as a proxy currency against the yuan. The won, which had depreciated similarly to the dollar index since the beginning of the year, depreciated faster than the U.S. dollar's strength since mid-August, causing a concentration effect. The Bank of Korea intervened in the foreign exchange market to ease volatility, according to the explanation.

Governor Lee emphasized that while the rapid depreciation of the exchange rate complicates and makes the Bank of Korea's monetary policy decisions difficult, the situation differs from the financial crises of 1997 and 2008. He said, "Unlike the 1997 Asian financial crisis, which had significant maturity and currency mismatches, Korea currently holds net external financial assets equivalent to 41% of its gross domestic product (GDP)." He assessed, "Considering foreign exchange reserves exceeding $410 billion and a lowered ratio of short-term external debt to foreign exchange reserves, foreign currency liquidity is very sound." He also noted that unlike just before the two crises, the real effective exchange rate has not deviated significantly from the long-term average to an overvalued state, and despite the exchange rate rise, Korean paper (KP) spreads and CDS premiums remain low, showing no signs of deteriorating dollar funding conditions.

Bank of Korea Governor Lee Chang-yong is presiding over the regular Monetary Policy Committee meeting held on the 12th at the Bank of Korea in Jung-gu, Seoul. Photo by Joint Press Corps

Governor Lee said, "Although the global growth outlook has been downgraded, increasing downside risks to growth, the unexpected rise in the exchange rate has raised the likelihood of sustained high inflation levels in the 5-6% range." He added, "The Bank of Korea does not aim to defend a specific exchange rate level, but it cannot ignore the potential financial stability risks that rapid exchange rate fluctuations may bring, such as increased capital outflow pressures."

Regarding the future direction of monetary policy, he said, "As long as the high inflation rate in the 5-6% range persists, the policy stance prioritizing price stability will continue." However, he did not specify the magnitude of future rate hikes, unlike in July, due to significant uncertainties regarding the Fed's November decision, energy price movements following OPEC+ production cuts, potential changes in China's zero-COVID policy after the Party Congress, and volatility in the yen and yuan.

Governor Lee also shared his reflections six months after assuming office as the Bank of Korea Governor in April. He said, "During my nine years at the International Monetary Fund (IMF), I took pride in contributing to the development of an integrated policy framework for small open economies, which combines monetary policy tools such as foreign exchange market intervention, capital flow management measures, and macroprudential policies as needed, rather than relying solely on interest rates." However, he acknowledged, "In practice, over the past few months of policy formulation, I realized how complex it is to find the optimal policy mix in reality." He added that he has keenly felt the significant constraints in applying the integrated policy framework when dealing with capital outflows, unlike when responding to capital inflows.

Governor Lee also mentioned that communicating the transition to forward guidance was more challenging than expected. He said, "It is true that moving away from the long-standing practice of avoiding mentioning future interest rate paths as a virtue is practically difficult. Considering the characteristics of a small open economy where external factors are hard to control, we may need to reconsider to what extent and at what pace this practice should be changed."

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