South Korea’s Economic Challenges
South Korea’s central bank governor, Rhee Chang-yong, has warned that the country needs to prepare for a future where interest rates are so low that the bank will have limited ability to stimulate the economy through interest rate policy alone. This situation is known as the effective lower bound (ELB).
What is the Effective Lower Bound?
The ELB refers to the minimum threshold for nominal interest rates, below which further rate cuts could be detrimental to the economy. Rhee believes that South Korea, as a newly advanced economy facing rapid population aging, risks reaching the ELB in the distant future.
Alternative Monetary Policy Tools
To deal with the ELB, Rhee proposes that emerging markets, including South Korea, consider implementing a funding for lending (FFL) scheme as an alternative to conventional monetary policy. Under the FFL framework, central banks provide low-interest funding to private financial institutions, which then channel credit to targeted sectors.
How FFL Works
The FFL scheme allows central banks to provide targeted support to specific sectors of the economy, such as small and medium-sized enterprises (SMEs) and self-employed individuals. This approach can help address the limitations of interest rate policy as a "blunt tool" that may not be effective in all situations.
Recent Monetary Policy Decisions
In January, the Bank of Korea (BOK) left interest rates unchanged at 3.0%, defying market expectations of a cut. Instead, the BOK used the lending facility to provide targeted support to SMEs and self-employed individuals. This decision reflected the bank’s use of the FFL facility to complement conventional policy tools.
Caution Against Quantitative Easing
Rhee cautioned against the adoption of quantitative easing and foreign exchange market intervention in South Korea, warning that these measures could cause adverse impacts such as draining high-quality liquid assets from the country.
Structural Reforms
The governor also called for structural reforms in South Korea, saying that he has expanded the scope of the BOK’s research beyond monetary policy to address structural issues tied to long-term growth, such as labor force participation, immigration, and regional development. Rhee believes that proactive prevention through structural reforms is the best policy to counter the ELB risk in Korea.
Conclusion
In conclusion, South Korea’s central bank governor has warned of the risks of reaching the effective lower bound, where interest rates are so low that the bank has limited ability to stimulate the economy. To address this challenge, Rhee proposes alternative monetary policy tools, such as the funding for lending scheme, and calls for structural reforms to promote long-term growth and stability in the economy. By taking a proactive approach, South Korea can mitigate the risks associated with the ELB and ensure a more sustainable economic future.
