BOK: "Monetary policy becomes difficult without structural reforms"... Responds to 'meddling' controversy

"Isn't the Bank of Korea simply an institution that adjusts interest rates or inflation? Isn't structural reform the responsibility of the government or the National Assembly?"

On the 6th, the BOK raised this question at the beginning of a post about structural reform on its official blog, stating, "Some people may be thinking this way." This appeared to be aimed at the ongoing criticism that BOK Governor Rhee Chang-yong has been excessively outspoken on various issues—including caregiving services, agricultural imports, and university admissions—since taking office.

In the blog post titled "Why does the central bank talk about structural reform?" by Hwang Indo, Director of the Monetary Policy Research Division at the BOK Economic Research Institute, who had previously highlighted the gravity of the issue through a low birthrate report—one of the series on structural reform—he emphasized, "Structural reforms directly affect monetary policy."

The BOK explained that if proper structural reform is not achieved and the economic fundamentals deteriorate, it will become difficult to adjust interest rates. The biggest issue is that, due to low birthrates and aging populations, the 'equilibrium real interest rate' declines. The BOK analyzed that since 1991, the trend of population aging has pulled down the real interest rate by 1.4 percentage points.

In a super-aged society, the decline in equilibrium interest rates occurs because the structure of funding demand and supply changes. Investment demand falls while, on the other hand, rising life expectancy leads households to save more for retirement. As the demand for borrowed funds drops and the supply from savings rises, excess funds accumulate in the market, and as a result, the value of money—i.e., the interest rate—drops.

When the equilibrium interest rate is low, the BOK has limited capacity to lower the base rate further to counter an economic downturn. Even a minor cut brings rates close to zero, significantly reducing policy maneuvering room.

Conflicts between the BOK’s policy goals of price stability and financial stability may also occur more often. As aging progresses, the economic growth rate slows and interest rates structurally trend downward. When rates fall, the net interest margins of financial institutions also shrink, decreasing profitability. In such situations, if financial institutions attempt to shore up earnings by investing in riskier assets, the overall stability of the financial system can worsen. This means a situation may arise in which weak growth and financial instability appear simultaneously.

Conversely, raising the base rate if the economy overheats becomes more challenging. This is because as aging intensifies, welfare expenditures continue to rise. Increasing rates could add fiscal burdens to the government, potentially leading to a vicious cycle where government debt increases again to cover those costs, the BOK warned.

Hwang stated, "Structural reform is about strengthening the muscles of the economy, and these muscles are necessary for the interest rate tool to have power." He added, “Reforms are needed to address structural problems that weaken the fundamentals of the economy and constrain the space where monetary policy can function properly."

Kang Jin-kyu, journalist josep@hankyung.com