The government’s economic policy directions for 2016 and the central bank’s inflation target for 2016-18, which were announced last week, have signaled a major shift in Korea’s macroeconomic management.

Forecasting the country’s gross domestic product would grow by 3.1 percent in real terms next year, government policymakers said attention would be paid equally to the nominal growth rate, which they expected to reach 4.5 percent in 2016.

Their remarks were interpreted as suggesting policy efforts would be strengthened to boost prices as Korea’s real growth rate, which is adjusted for inflation, has remained stalled in recent years.


In time for the disclosure of the economic policy directions, the Bank of Korea announced it had set its inflation target for the next three years at 2 percent. This goal, which was lowered from a target band of 2.5-3.5 percent for the period between 2013 and 2015, represents a substantial rise from actual inflation that remained below 1 percent for 11 consecutive months until a 1 percent year-on-year gain in November. So far, increases in consumer prices have hovered below the target band every month.

Economists see the BOK’s move as a sign that its role is changing from an inflation fighter to a deflation fighter.

Last week’s announcements by the fiscal and monetary authorities seemed a belated acknowledgment that it would be impossible for the Korean economy to return to the era of high growth accompanied by high inflation. They are now increasingly concerned that Korea may be following in the footsteps of Japan, which had suffered an economic recession for more than two decades since the early 1990s partly due to a failure in keeping prices at a proper level.

The government’s pledge to pay an equal heed to the nominal and real growth rates reflects its intention to prevent consumer and business sentiments, which are actually affected by the former, from being overly dampened to result in reduced spending and investment.

“It may risk being detached from reality to adhere only to real growth rates in a situation where deflationary pressures are building up,” said Shin Min-young, an economist at LG Economic Research Institute.

With the suggested shift in macroeconomic approaches met with some positive response, concern has been raised that the government’s efforts to prop up the nominal growth may result in limiting room for the central bank in choosing monetary policies.

“The possibility cannot be ruled out that the independence of monetary authorities may be harmed,” said You Jong-il, a professor at the Korea Development Institute School of Public Policy and Management.

Policymakers in the government and the central bank have so far struck a cooperative note on the need to strengthen efforts to raise inflation.

At a press briefing on the 2016 economic policy directions last Wednesday, Finance Minister Choi Kyung-hwan emphasized the importance of a proper mixture of fiscal and monetary policies. Choi, who concurrently serves as deputy prime minister for economic affairs, expected the Bank of Korea to collaborate with the government by helping bolster prices.

A senior BOK official said on the same day the central bank would do its best to ensure the economy would emerge from low inflation.

Some economists, however, note it is not guaranteed the government and the central bank will continue to keep step with each other down the road -- particularly on whether to lower interest rates.

Despite their pledge to fight off deflation threat, the Finance Ministry and the BOK have made no mention on what specific tools to use.

The central bank said that if the inflation rate would miss the target for more than six months, its governor would come forward to explain the reason and suggest the direction of future monetary policy. The BOK head would hold such a session with reporters every three months if the 2 percent target would continue to be missed. Economists say this move, which could be seen as equivalent to a verbal intervention in the market, would fall short of giving a significant boost to price hikes that are estimated to remain at 0.7 percent this year.

The government’s emphasis on nominal growth is expected to put pressure on the central bank to be more positive toward further cutting its key interest rate, which has been kept at a record low of 1.5 percent since June. Government policymakers are left with few effective policy tools to boost the economy as they have used nearly all available fiscal stimulants.

BOK officials remain cautious on cutting rates, saying inflation is seen to be on course to rise toward 2 percent in 2017. In fact, the central bank will be facing an increasing pressure to raise rates next year to prevent possible capital outflow as the U.S. Federal Reserve is expected to keep a streak of rate rises probably to 1.25-1.5 percent by the end of 2016.

But a rising household debt may be holding back the central bank from raising rates as analysts estimate a 1 percent increase will result in indebted households paying 7.7 trillion won ($6.5 billion) more in annual interest payments.

By Kim Kyung-ho (khkim@heraldcorp.com)