Lee Chang-yong, the Governor of the Central Bank, emphasized on the 23rd (local time) that the 'separation principle' and 'prudent regulation' are important for the Central Bank to fulfill its role during high inflation periods.
Governor Lee noted during the 'Monetary policy and financial stability during inflation' session at the International Monetary Fund (IMF) and World Bank (WB) Spring Meeting held in Washington, D.C., that "we must deeply analyze what structural changes are necessary for operating monetary policy in a changing environment."
In the session, Governor Lee introduced the challenging situation in which the Central Bank had difficulty implementing monetary policy during the high inflation period experienced in Korea in 2022. He explained that during the global 'hyperinflation' period, the United States implemented three 'giant steps' (75 basis point increases), while Korea also took two 'big steps' by raising rates by 50 basis points.
The Governor continued, "Such rapid interest rate hikes affected the stability of the financial markets," adding that "particularly in Korea, we had to provide liquidity despite the trend of rising interest rates due to debt in the real estate and household sectors." He stated, "A second issue is the sharp increase in exchange rates due to the widening interest rate gap with the United States," and noted, "The depreciation of the exchange rate led financial institutions to access the Korean won money market, causing domestic interest rates to rise further. During the tightening policy, the financial situation was tightened much faster than expected."
Governor Lee said, "We had to continue tightening monetary policy to combat inflation," stating that "Korea's inflation was driven by factors in the global market, so we could not stop the trend of raising interest rates."
He added, "At the same time, we had to provide liquidity to specific sectors, and interventions in the foreign exchange market were also necessary to prevent exchange rate fluctuations," stating, "There were many conflicting objectives. I tried to explain this through the separation principle, but it was not effective." He continued, "Some pointed out that 'raising interest rates sharply caused a financial crisis,' while others said, 'Providing liquidity to specific sectors while pursuing a tightening policy is contradictory,' and I frankly don't know how to solve this issue."
Regarding the roles and tasks of the Central Bank during inflationary periods, he said, "To provide liquidity to specific sectors, some regulatory relaxation is necessary," adding, "This is not an easy problem. While there was much leverage in a situation of loose regulation, when problems arise, it becomes necessary to loosen those regulations." He remarked, "Even if used in a limited manner, there are criticisms that it constitutes 'quasi-fiscal activity,'" and stated, "When necessary, various tools must be combined and utilized."
Governor Lee emphasized that the Central Bank needs independence to focus on price response. He stated, "The biggest reason we were able to maintain inflation response as the top policy during the financial crisis in 2022 is that I was the Central Bank governor for a four-year term," adding that "the terms of regulatory authorities or the Minister are typically shorter than two years."
Governor Lee further revealed the policy tools under development to strengthen the role of the Central Bank, including ▲liquidity provision tools ▲permanent lending systems ▲foreign exchange market interventions ▲strengthening soundness regulations. He noted, "Reflecting on the recent difficulties in financial markets, the high leverage of non-bank financial institutions was one of the major causes," and added that "the changing characteristics of the foreign exchange market are also very important. In a changing environment, we must deeply analyze what structural changes are necessary for operating monetary policy."