[Q&A] Bank of Korea: "Addressing Household Debt through Monetary and Macro Policy Coordination... Additional Micro Policies Needed if Markets Shake"

September Monetary and Credit Policy Report Press Briefing
"No Appropriate Level for Housing Prices, but Overvaluation Is Certain"

The Bank of Korea emphasized the need to resolve the accumulated financial imbalances through coordination between monetary policy and macroprudential policy. Regarding real estate prices, it warned that "there are mixed upward and downward factors," but "no matter which indicator you look at, it can be said that prices are overvalued."

On the 14th, Lee Sang-hyung, Deputy Governor of the Bank of Korea, said at a press conference on the September Monetary and Credit Policy Report that since the Bank of Korea is emphasizing deleveraging (repayment and reduction of borrowing), it is necessary to actively speak out about the government's macroprudential policies. He stated, "I think it is necessary to respond for stable growth in the medium to long term," and added, "We are currently consulting with the government on specific policies such as the operation plan for DSR (debt service ratio)."

Deputy Governor Lee said, "Depending on the financial imbalance situation, including household loan conditions, it is necessary to operate monetary policy tightly for a considerable period," and added, "Unlike other countries, Korea has not experienced full-scale deleveraging for over 20 years, so we are cautious. However, if there is a possibility that the entire market could be shaken during this process, micro-level responses are also necessary."

Below is a Q&A from the press conference on the Monetary and Credit Policy Report.

- You mentioned that monetary policy and macroprudential policy should go hand in hand regarding the household debt issue, referring to their 'coordination.' However, Governor Lee Chang-yong drew a line last month at the Monetary Policy Committee press conference, stating that since the government has greater authority over household debt, there will be no interest rate hikes to address debt. Does 'coordination' mean maintaining the current interest rate level for an extended period?

▲ So far, monetary policy has been operated tightly with a focus on price stability. Macroprudential policies, which were significantly strengthened before the COVID-19 pandemic, were considerably eased as financial markets became unstable and concerns about a hard landing in the housing market grew. Since then, while the possibility of a soft landing in real estate has increased, household debt has expanded. Considering that financial imbalances have accumulated, we judge that the rising household debt ratio is undesirable, and this is a point on which we have consensus with the government. From a monetary policy perspective, it is necessary to operate tightly for a considerable period depending on the recent economic conditions, inflation, and financial imbalance situations, including household loans. From the macroprudential policy side, I think it is necessary to carefully examine the recent causes of household loan increases and prepare and implement appropriate countermeasures. The measures announced by financial authorities the day before are also policies in this regard. If household loan ratios tend to rise despite these policies, the government and the Bank of Korea will closely cooperate and seek further response measures if necessary.

- The Bank of Korea, which emphasizes household debt deleveraging, is there room for it to actively speak out about the government's macroprudential policies, such as deleting DSR exemption rules?

▲ I think it is necessary to respond for stable growth in the medium to long term. We are consulting with the government on specific policies. We are also discussing the operation plan for DSR with financial authorities. Additionally, as the second-largest shareholder of the Korea Housing Finance Corporation, the Bank of Korea continues to convey opinions to the Financial Services Commission.

- Please evaluate the financial imbalances during the recent interest rate hike period. Is the surge in household loans and the rebound in real estate prices ultimately the result of a mismatch between monetary policy and macroprudential policy?

▲ The two policies have common goals as well as their own objectives. Over the past decade, financial imbalances have tended to accumulate without being alleviated during the operation of monetary and macroprudential policies. Currently, monetary policy is focused on price stability. Macroprudential policy primarily responded to financial market instability and the risk of a hard landing in the housing market at the end of last year. In that process, household loans increased more than expected. In such an environment, macroprudential policy may have positive effects as well as unexpected side effects. Since the policy combination has been implemented only recently, it is too early to judge. With financial market instability easing and the possibility of a soft landing in real estate increasing, while household loans are expanding, how to manage macroprudential policy going forward is important.

- Are micro-level policies such as reverse jeonse (key money deposit) support policies shaking macro policies?

▲ The reason we implemented micro policies was because financial imbalances had accumulated and the market was unstable. From a medium to long-term perspective, we believe there is policy consistency. Unlike other countries, Korea has not experienced full-scale deleveraging for over 20 years, so we are cautious. However, if there is a possibility that the entire market could be shaken during this process, micro-level responses are also necessary.

- Regarding real estate, what do you think should be corrected first to resolve the accumulation of debt? Are you still concerned about a hard landing?

▲ There is usually a 2 to 3-month lag between housing transaction volume and housing-related funding demand (loans). This is a typical pattern. We will assess policy effects and housing market conditions to forecast future household loan increases and work closely with the government to support measures to prevent the household debt ratio from rising. The housing market has mixed upward and downward factors, making it difficult for us to make forecasts. However, it is true that the housing market is overvalued.

- You continue to leave open the possibility that interest rates could rise to 3.75%, but almost no research institutions expect such an increase. Is this just symbolic?

▲ Considering various policy environments, inflation rates, decisions by the U.S. Federal Reserve, and financial imbalances, which are significant factors, we will observe how these factors unfold. Rather than interpreting 3.75% as a level we "must raise to," it should be understood as indicating that "there is upward pressure" based on the current situation. It should not be approached based on whether the market believes it or not.

- On the 5th, the Bank of Korea blog stated that the inflation path would not be smooth but would show a slowing trend. Yet, a week later, you mentioned the possibility of a delay in the slowdown of inflation. Why was the tone adjusted?

▲ We have not changed our inflation forecast or assessment. The August consumer price inflation rate came out at 3.4%, mainly due to rising international raw material and agricultural product prices. This is not significantly different from what we expected at the August monetary policy direction meeting. We still expect inflation to remain high until September and then stay around 3% due to base effects and stabilization of agricultural product prices after October. However, since international oil prices have risen more than expected and agricultural product price trends are unpredictable, we intend to closely monitor the inflation trend.

- Corporate debt is also increasing. Should we worry about it as much as household debt? Are there management measures?

▲ Looking at the corporate sector, leverage remains high after the pandemic. There are various causes, so we need to examine them specifically. Public sector debt has increased since the past, and recently, debt repayment deferrals after the pandemic seem to have had an impact. It is true that this is relatively high compared to other countries. We need to see if this can be reduced. Household and corporate sectors are different. Corporations are legal entities, so their borrowing factors are heterogeneous. The household sector is mostly homogeneous, consisting mainly of mortgage loans.

- The report mentions that housing prices are overvalued. The price-to-income ratio is 26 times; what is the appropriate level?

▲ It means that it takes 26 years of average annual household income to match the housing price. No matter which indicator you look at, it can be said that prices are overvalued. However, there is no separate standard for "appropriate." The standard is usually the historical average price or comparison with other countries. It is difficult to say there is an appropriate level like an inflation target. However, since the trend significantly exceeds the norm, it can be said to be overvalued.