[In-Depth Look] Why the Bank of Korea Should Be Freed

The Yoon Suk-yeol administration was inaugurated on May 10. While offering congratulations, from the government's stance that the Bank of Korea should not be interfered with in performing its role, there is a somewhat dampening request to make. This is because the inflation situation is an emergency.

In April, the consumer price index rose by 4.8%, marking the highest level since the 2008 global financial crisis. The perceived inflation, including food and beverages, also surged to 5.7%, continuing its high ascent. It remains difficult to predict the end of this steep upward trend.

The main culprit is excessive monetary expansion. Most countries lowered their benchmark interest rates to near zero and significantly increased fiscal spending to overcome the crisis. The disruption of the global supply chain, which efficiently produced and supplied goods at the lowest cost, also contributed. Labor shortages caused by many people not returning to work even after the COVID-19 situation improved fueled wage increases.

The United States is in a more urgent situation than we are. The consumer price inflation rate in March was 8.5%, double our level. The U.S. Federal Reserve is expected to sharply raise the benchmark interest rate from 1.0% to 2.5% by the end of this year. Unfortunately, this aggressive stance has not quelled skeptical public opinion.

On April 23, The Economist concluded that the U.S. Federal Reserve has failed. It argued that expecting consumer prices to stabilize at 2.3% in 2024 by raising the benchmark interest rate to 2.75% by next year is overly optimistic. It warned that the Federal Reserve would need to raise rates to 5-6% to achieve its goals.

In the same context, it is not possible to rule out the possibility that South Korea will need to raise its benchmark interest rate from the current 1.5% to 2.5% or higher within this year. This will be a difficult situation for the new government. Companies always want low interest rates, and individuals will complain about the burden of high rates. The discontent of struggling self-employed people and the younger generation who bought homes through aggressive borrowing and investment will grow into calls to slow the pace of rate hikes.

If the top priority of national governance is price stability, the new government must allow the Bank of Korea to operate freely. In other words, the Bank should be allowed to make interest rate decisions with conviction. The case of Japan in the late 1980s serves as a cautionary tale. In 1985, the Plaza Accord caused the yen to appreciate, making it difficult for export companies. At a time when interest rates needed to be raised to ease their burden, the central bank instead retreated. This led to the creation of an asset bubble and the lost 30 years. This is why the lack of independence of the Bank of Japan is always regretted.

The government cannot afford to just watch the Bank of Korea. Although painful, fiscal tightening is necessary. While it may be difficult to tighten to support small and medium-sized businesses, at least operating at a neutral level is required. To reduce the pain of perceived inflation for ordinary citizens, money should not be spared for overseas raw material stockpiling and release projects. It is inevitable to be prepared to use foreign exchange reserves to lower import prices. Considering the precedent when the MB administration released $60 billion, about 24% of reserves, during the 2008 crisis, even $100 billion would not be regrettable. Resuming currency swaps with the U.S. to secure funding is also a good method.

The Yoon Suk-yeol administration must do its best to prevent high inflation from becoming a stumbling block for our economy, but it must not forget that the starting point is to guarantee that the Bank of Korea can act independently and neutrally.

Choi Kwang-hae, CEO of Woori Financial Management Research Institute