[Viewpoint] Bank of Korea’s Government Bond Purchases and the (Un)Transparency of Monetary Policy

Kim Hong-beom, Professor Emeritus, Department of Economics, Gyeongsang National University

Following a slight increase in the base interest rate in November last year, it was raised again in January this year. With supplementary budgets being discussed from the beginning of the year, the issuance of deficit government bonds was also anticipated. As a result, government bond yields surged. In response, the Bank of Korea (BOK) simply purchased 2 trillion won worth of government bonds in early February. A few days later, at the macroeconomic and financial meeting, the BOK governor agreed to "timely implementation" of "additional simple purchases of government bonds," among other measures. This can be interpreted as conducting monetary policy while taking into account supplementary budgets and government bond issuance. Has the government’s fiscal policy come to dominate the BOK’s monetary policy (fiscal dominance)?

Simple purchases of government bonds are recorded on the BOK’s balance sheet as an increase in monetary liabilities (base money). This is a primary factor leading to an expansion of the money supply in the market. The recent rapid deterioration of fiscal soundness has greatly increased the risk that simple purchases will be abused as a means of monetizing national debt. If frequent supplementary budgets make simple purchases of government bonds regularly necessary, the current reality is that autonomous monetary policy is a pipe dream for the BOK, which finds it difficult to control base money.

Nevertheless, it is hard to fault the BOK governor’s explanation that simple purchases of government bonds have been for the purpose of "market stabilization." BOK publications also state that simple purchases are for "securing government bonds for RP sales" or "stabilizing financial markets when market interest rates surge." The problem is that the governor’s explanation remains at a theoretical level and lacks sufficient persuasiveness.

The size of government bonds held by the BOK, which was 14.5 trillion won at the end of 2016, doubled to 29.0 trillion won by the end of 2021, a five-year period that is markedly different from the previous five years. At the end of 2011, the BOK’s holdings of government bonds were about 14.4 trillion won, similar to the level at the end of 2016 (BOK ECOS). Meanwhile, during the current governor’s eight-year tenure (April 2014 to March 2022), simple purchases of government bonds have been conducted 34 times, totaling 34.5 trillion won (especially, 18 times and 23.1 trillion won in the latter four years). This contrasts with the previous eight-year period (April 2006 to March 2014), which saw 15 purchases totaling 9.0 trillion won (BOK website).

Can the recent significant increase in the size of government bonds held by the BOK, as well as the frequency and size per transaction of simple purchases, be neatly explained solely as "securing government bonds for RP sales" or purely for "market stabilization"? The BOK must provide detailed and clear explanations to address these reasonable suspicions, for the sake of monetary policy transparency.

In this regard, the history of the U.S. Federal Reserve shows what "best discipline" looks like. At the end of January 1951, when the Korean War was intensifying, President Truman summoned all members of the Federal Open Market Committee (FOMC), which determines monetary policy, to the White House to request market purchases related to government bond issuance for war financing. No decisions were made at that meeting, but the White House issued a statement that the Fed had promised cooperation, followed by a presidential letter. Among the FOMC members at the time was Mariner Eccles, a former Fed chairman. He resolved to stand firm against the president and boldly released the meeting minutes to the press. The startled government had no choice but to officially recognize the Fed’s independence. This became the famous "Treasury-Fed Accord" (March 1951) (Richmond Fed materials).

Seventy-one years ago, the pursuit of transparency by a single FOMC member with steadfast guts granted the Fed monetary policy independence. That profound resonance is both great and deep for us today.

Kim Hongbeom, Professor Emeritus, Department of Economics, Gyeongsang National University