Super-budget and back-to-back hikes at the same time

Stepping on the gas and brakes simultaneously

Higher potential growth rate would lift neutral rate

Room for tighter monetary policy would expand

'Reviewing concepts … will announce soon'

Bank of Korea Governor Shin Hyun-song answers questions at a press conference following the Monetary Policy Board's rate decision at the Bank of Korea headquarters in Jung-gu, Seoul, on Thursday. [Yonhap]
Bank of Korea Governor Shin Hyun-song answers questions at a press conference following the Monetary Policy Board's rate decision at the Bank of Korea headquarters in Jung-gu, Seoul, on Thursday. [Yonhap]

With the government pushing a "super budget" of more than 800 trillion won ($580 billion), the Bank of Korea's second consecutive benchmark interest rate hike has reignited debate over a mismatch between expansionary fiscal policy and tightening monetary policy.

Governor Shin Hyun-song has argued that expansionary fiscal spending does not conflict with tight monetary policy as long as it is directed toward raising the potential growth rate — because a higher potential growth rate also pushes up the neutral rate. How much the Bank of Korea's current estimates of the potential growth rate and neutral rate rise is expected to determine whether the mismatch debate can be resolved.

At a press conference following Thursday's Monetary Policy Board meeting, Shin addressed criticism over the apparent conflict between fiscal and monetary policy. "Whether fiscal spending and monetary policy are out of sync seems to depend on the nature, scale and purpose of the fiscal spending," he said. "If fiscal outlays are applied to investment that can lift future growth, they can raise the potential growth rate and the mismatch may not exist."

Expansionary fiscal policy and tight monetary policy generally pull in opposite directions. Expansionary fiscal policy involves the government injecting money to stimulate the economy, while tight monetary policy does the reverse — absorbing liquidity to prevent overheating. The dynamic is often compared to pressing the accelerator and the brake at the same time.

The picture changes, however, if fiscal spending does more than provide a temporary economic boost — if it restructures the fundamentals of the Korean economy and lifts its underlying growth trajectory. Shin's emphasis on the "nature, scale and purpose" of fiscal spending, and his stated intention to monitor how it unfolds, reflects that same logic.

The budget framework the ruling party and government announced Tuesday identifies five priority investment areas, among them AI and three mega-projects as well as expanding future growth engines — categories that broadly match the type of investment Shin described. How large a share of the budget is ultimately allocated to innovation sectors as deliberations proceed will be a key factor to watch.

If government fiscal spending succeeds in raising the potential growth rate, the neutral rate would rise in tandem, giving the Bank of Korea more room to pursue a tighter monetary policy stance.

The potential growth rate refers to the rate of growth an economy can sustain when all its resources are fully utilized. A declining potential growth rate signals a weakening in the economy's fundamentals and long-term growth capacity. The neutral rate is the ideal interest rate level at which the economy can grow steadily without pushing inflation up or down — it serves as a compass for monetary policy.

The OECD has put South Korea's potential growth rate for this year at 1.66 percent. The Bank of Korea estimates it at around 2 percent or slightly below. The government has recently set out a blueprint to lift the potential growth rate to 3 percent.

Estimates of the neutral rate vary across studies, but the Bank of Korea is believed to place it in the range of 1.8 to 3.3 percent. In a written response submitted earlier to the office of People Power Party lawmaker Kwon Young-se, the central bank presented five research findings on the neutral rate level, with a common range of 1.8 to 3.3 percent.

At the time, the Bank of Korea said it does not disclose a specific neutral rate figure, noting that the neutral rate is an unobservable variable subject to high estimation uncertainty with wide variation depending on the methodology, and that assessing the monetary policy stance requires weighing not only the neutral rate but also inflation, growth trends and financial stability conditions. It added, however, that "in light of internal and external research on South Korea's neutral rate, the current benchmark rate of 2.75 percent — as of end-July — is assessed to fall within the estimated neutral rate range."

The Bank of Korea is expected to release updated estimates of the potential growth rate and neutral rate calibrated to current economic conditions in the near future. "We are reviewing all concepts, including the potential growth rate and the neutral rate, again," Shin said. "There will be an opportunity to make an additional announcement on that." Given current growth momentum driven by the semiconductor sector, among other factors, the revised estimates could come in significantly higher than previous figures.

The Bank of Korea has not previously disclosed its neutral rate estimates, and it remains to be seen whether it will this time provide specific figures. With expansionary fiscal policy and a tightening monetary stance both expected to continue, there is also speculation that the central bank may move to release its potential growth rate and neutral rate estimates as soon as possible — in part to address the ongoing mismatch debate head-on.


kimstar@heraldcorp.com