[BOK Focus] Changing the Inflation Target to 3%? Why the Bank of Korea Is Troubled

[Asia Economy Reporter Seo So-jeong] As the U.S. Federal Reserve (Fed) continues to raise its benchmark interest rates to curb inflation, fierce debates are unfolding within the American economic community over the appropriateness of the 2% inflation target. With the era of low inflation ending and inflation becoming prolonged, some argue that the Fed’s current 2% inflation target should be raised to 3%. On the other hand, there is a strong counterargument that since inflation is expected to approach 2% in the long term, there is no need to adjust the inflation target.

Joseph Stiglitz, Nobel laureate and professor at Columbia University, described the 2% inflation target as "complete tyranny," warning that "the process of reaching 2% inflicts even harsher tyranny on households and businesses" and that "the rush to reach 2% will come at a costly price." While the debate over the 2% inflation target intensifies among leading economists in the U.S., cautious voices are also emerging in South Korea calling for an adjustment of the 2% inflation stabilization target. Currently, most advanced countries set their inflation stabilization targets at 2%. The U.S. Fed announced in January 2012, through its "Long-Run Goals and Monetary Policy Strategy," that a 2% inflation rate aligns with its price stability mandate. The Bank of Korea first introduced the inflation stabilization target system in 1998. Since then, based on core inflation rates, the target has evolved as follows: 2000 (3% ± 1 percentage point), 2004 (2.5?3.5%), changed to consumer price index as the target indicator in 2007 (3.0% ± 0.5 percentage point), 2013?2015 (2.5?3.5%), and from 2016 onward, a single target of 2% was set.

At a year-end press conference in December last year, Lee Chang-yong, Governor of the Bank of Korea, was asked about the need to change the inflation stabilization target. He responded, "Previously, the inflation target was a band, but it changed to a single number," adding, "If South Korea is likely to experience low inflation due to aging, that would be an important issue, but given the current (high inflation) situation, it is difficult to say we should raise it to 3%." Governor Lee emphasized, "Just talking about changing the inflation target now could have a very negative impact on expectations," and firmly stated, "This is not the time to make such changes."

Governor Lee reiterated his stance during a press briefing on monetary policy direction on the 13th. He said, "There are many questions about what to do if inflation falls more slowly than the Bank of Korea expects, or whether to raise the inflation target from 2% to 3% in such a case, but I think that is the worst approach," explaining, "Moving the goalposts now would cause inflation expectations to fluctuate too much." He added, "That discussion can take place after inflation stabilizes," and "If inflation does not converge to the target as quickly as the Bank expects, we should respond with interest rate adjustments rather than changing the inflation target."

Ham Jun-ho, former Monetary Policy Committee member and professor at Yonsei University Graduate School of International Studies, said, "Debates over inflation targets continue at major central banks such as those in the U.S. and Japan," but cautioned, "Changing the target itself during the process of raising interest rates to control high inflation is like moving the goalposts mid-game, which could be seen as a post hoc excuse." While discussions on an appropriate inflation target may be necessary once inflation stabilizes, he warned that advocating for a target revision amid persistent high inflation in the 5% range could be perceived as the central bank making excuses for failing to meet its goals.