South Korea’s economy is in a tough spot. Too bad the monetary policy response has been so tame.

The country is flirting with outright deflation, figures Tuesday showed, as consumer prices declined for the first time on record. Exports, which account for about 40 percent of gross domestic product, had slipped for 10 straight months. The Bank of Korea says the country will struggle to meet even lowered growth forecasts.

BOK policymakers need to articulate a broad strategy to get inflation back to the 2 percent target -- and in the process reflate the overall economy -- rather than dole out piecemeal responses every time they meet to set interest rates. This includes consideration of measures once seen as unconventional, but now thoroughly mainstream outside Korea, such as negative interest rates or quantitative easing -- or both.

Korea is in the rare situation where fiscal policy is expansive, but monetary policy is too cautious. Usually the problem is the other way around. President Moon Jae-in proposed a spending increase of about 9 percent for this year’s national budget, the most in a decade. That’s not going to turn the economy around when the central bank has trimmed borrowing costs just once this year.

The BOK’s stance is also looking conservative relative to peers that have cut rates multiple times in recent months. Neighboring Japan is considering lowering rates even further into negative territory, while the European Central Bank did so last month and revived QE. Even officials in Australia and New Zealand are weighing these once unthinkable prospects, as I wrote here.

Korea’s benchmark stands at 1.5 percent. There’s a way to go to zero, but not a lot, given the scope of the country’s challenges. The US-China trade war has slashed exports, especially in the technology sector, and a separate spat with Japan looks like a self-inflicted wound.

BOK Gov. Lee Ju-yeol acknowledged his uphill battle in comments over the weekend. Inflation will probably be below zero for a few months, Lee said, though he dismissed the prospect of entrenched deflation. The governor reminded his audience that the central bank has an “accommodative stance” and will look at “every set of data possible” when policymakers meet Oct. 16.

One factor constraining the BOK could be financial stability. This aspect of its mandate can hamper efforts to respond quickly to economic changes, the International Monetary Fund noted in a working paper in May. There’s certainly reason to worry: The Korean won is one of the world’s worst-performing emerging-market currencies so far this year, and foreigners have sold $861 million of the country’s stocks this month alone.

Still, that’s not enough to justify inaction. Inflation has consistently fallen below the BOK’s 2 percent target since it was set three years ago. By lowering its target from a range of 2.5 percent to 3.5 percent, officials may have inadvertently sowed the idea they have given up on a meaningful commitment to stimulus, regardless of what circumstances warrant.

The BOK has a chance to dispel this notion. The format of its statements leaves plenty of room: Let’s have some proper forward guidance similar to what top-tier central banks issue. The BOK could cut rates by half a point, rather than the generic quarter-point job, and pledge they will stay at that level (or lower!) until the trade war ends or inflation approaches its target. Lee should make clear in his post-decision briefing that all options are on the table -- and act like he means it.

It’s legitimate to ask whether the whole concept of inflation targeting has passed its use-by date. It was a product of an era when too much inflation was seen as the bigger threat, not the situation that prevails today. As long as the target is in place, Korea needs to make a stab at reflation.

The BOK certainly isn’t the only central bank to miss its inflation targets; but just because it’s in good company, that doesn’t mean the economy should be miserable. 


Daniel Moss
Daniel Moss is a Bloomberg Opinion columnist covering Asian economies. -- Ed.

(Bloomberg)