Bank of Korea pushes to expand reform from '3-month interest rate outlook' to '1-year dot plot'

The Bank of Korea is considering a plan to expand the forward guidance of Monetary Policy Board members. It intends to reform the current format, which presents the possibility of the direction of interest rates three months ahead, into a dot plot that directly shows interest rates within one year.

On the 15th, the Bank of Korea held a monetary policy conference under the theme "Challenges of Bank of Korea Monetary Policy: Communication and Policy Tools" and listened to outside experts' opinions on such measures. Shin Seong-hwan, a Monetary Policy Board member who delivered the keynote speech, explained, "We will refine forward guidance and strive to improve qualitative communication," and added, "We will work to enhance the transparency and predictability of policy."

Since November 2022, the Bank of Korea has, after deciding the policy rate at Monetary Policy Direction meetings, publicly disclosed the three-month-ahead interest rate direction of the six Monetary Policy Board members in the form of 'possibilities' at press briefings. At last month's Monetary Policy Board meeting, Governor Lee Chang-yong answered a related question by saying, "Three of the six believe it is highly likely that the rate will be maintained at annual 2.5% three months from now, and the other three believe that the possibility of a cut should be left open."

The Bank of Korea assessed that the introduction of such forward guidance has helped the market in terms of predictability, credibility, and information power. In particular, it analyzed that market interest rate volatility on the day of the monetary policy direction decision was reduced from an average of 0.04% point to 0.03% point. Kim Byung-guk, head of the Bank of Korea policy coordination team, explained, "Survey results of economic agents showed that the three-month interest rate outlook has a positive effect on policy communication, and many respondents said they use it as a key variable when predicting rates."

The Bank of Korea said it has been conducting a pilot test of conditional interest rate forecasts since July last year. First, it is working on presenting what was shown as possibilities as explicit interest rate levels. For example, in last month's case where three members saw the possibility of a freeze within three months and three saw the possibility of a cut, it could be expressed as annual 2.50% for 3 members and annual 2.25% for 3 members. If among the members who left open the possibility of a cut some were considering more than one cut, it would also be possible to present it as annual 2.50% for 3 members, annual 2.25% for 2 members, and annual 2.50% for 1 member, etc.

An option under consideration is for a member to present two or more interest rate levels. The six Monetary Policy Board members would each present two or three rate levels, resulting in a total of 12–18 dots in the dot plot. If a board member wants to emphasize a freeze at three months while leaving a slight possibility of a cut, they could express this by assigning two dots to annual 2.50% and one dot to annual 2.25%.

A plan to extend the forecast horizon from the current three months to one year is being considered. In this case various numbers can be presented, but there are concerns that the dot plot's distribution will widen as the horizon lengthens.

The Bank of Korea said, "Expanding the forecast horizon and adopting the dot-plot method could improve the predictability of monetary policy," but added, "It is necessary to pay attention to issues such as the widening of the dot plot's distribution and the possibility of discrepancies with the policy rate decision." It also said, "While continuing the pilot test, we will discuss future operational plans such as the forecast horizon and presentation method in communication with economic agents."

Monetary Policy Board members who will operate this system agree with providing more information to economic agents, but it is reported that there are still differences of opinion on the specific operational methods.

On that day, Commissioner Shin said that getting the market to accept that forward guidance is conditional is a prerequisite. He said, "(If the interest rate path presented in forward guidance) diverges from reality, policy credibility may be undermined," and pointed out, "In an environment where economic forecast errors occur frequently, market understanding that it is 'conditional' is essential."

Other board members who had held press briefings earlier also gave their views on expanding forward guidance. Kim Jong-hwa, a Monetary Policy Board member, expressed support for expanding forward guidance at a press briefing but emphasized the importance of agreement among board members. He said, "If consensus is difficult, we can first consider a plan to include specific rate levels in the current forward guidance of the three-month interest rate outlook." The idea is to present a concrete dot plot instead of the possibility of the direction three months later.

At a September briefing, Commissioner Hwang Geon-il also expressed the view that it would be desirable to present forward guidance on future interest rate policy on a one-year horizon. He said he prefers a presentation method of a dot plot in which each board member presents three dots.

Reporter Kang Jin-gyu josep@hankyung.com