KDI - Korea Development Institute - RESEARCH - Research Areas

Summary

Policy Study KOR Investor Composition of Government Debtand its Fiscal Implications

This paper estimates the demand for South Korea’s government bonds across investor categories and projects future bond yields in light of the country’s rising debt trajectory. A cross-country analysis shows that public and non-bank sectors have been key drivers of increased foreign investor holdings of Korean government debt during the COVID-19 pandemic. Using sectoral debt holdings data, the paper examines the evolution of marginal holdings of government bonds by each sector and estimates the responsiveness of debt demand to bond yield changes. Over the past decade, domestic banks and public institutions, including the National Pension Service, have reduced their marginal holdings, while private pension and investment fund sectors have increased theirs. These findings highlight the growing importance of non-bank sectors in government debt demand, consistent with the literature (Fang et al., 2022). Foreign investors exhibit the highest demand sensitivity to bond yields, whereas domestic insurance companies show the lowest. Based on sectoral demand estimates, a 10% increase in government debt is estimated to raise bond yields by 43 basis points. By 2030, when Korea’s government debt is expected to reach 2,000 trillion won, bond yields are projected to rise to 4.85%, ceteris paribus. Notably, 60% of the projected yield increase is attributed to the inelastic demand of insurance companies. This underscores the importance of adjusting the investor composition of the government bond market, with a greater share of investors with higher demand elasticity to alleviate pressure on borrowing cost.

Summary

Policy Study KOR Inflation Dynamics and Monetary Policy in an Aging Society: Insights from Consumption Patterns

South Korea, among the world’s fastest-aging nations, is projected to enter a super-aged society ― over 20% of the population aged 65 or older ― by 2025. Age-driven shifts in consumption patterns may significantly affect monetary policy effectiveness. This study analyzes the impact of age-specific consumption patterns on inflation and monetary policy outcomes, deriving policy implications.

Using consumption baskets, this study compares spending patterns across youth (15-34), middle-aged (35-64), and elderly (65+) cohorts. Findings reveal distinct consumption items by age group, with varying price rigidities. The elderly cohort primarily consumes items with frequent price fluctuations, suggesting a high likelihood of greater sensitivity to monetary policy changes.

Employing Jorda's (2005) local projection method, the study finds that tight monetary policy triggers a larger inflation decline among the elderly cohort than among the youth or middle-aged cohorts, reflecting the higher price flexibility of their consumption items.

These findings suggest that aging may diminish monetary policy’s impact on real consumption. To achieve policy objectives, the central bank must design policies that precisely reflect age-specific consumption patterns and price rigidities, with particular attention to the elderly’s consumption structure. In a rapidly aging society, detailed analysis of age-driven inflation responses and tailored policy measures are essential for monetary policy efficacy.

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Policy Study KOR Capital Flows and Challenges in the Digital Age: Focusing on Central Bank Digital Currencies (CBDCs)

As the digitalization of finance accelerates, discussions on the adoption of Central Bank Digital Currencies (CBDCs) are gaining momentum, particularly among G20 nations. This development calls for examining the potential impacts of CBDC implementation on both domestic and international financial markets and capital flow, alongside exploring appropriate response strategies. Upon reviewing the status and background of CBDC adoption among G20 countries, setting up a unified CBDC platform for this group in the short term is highly unfeasible. Instead, some emerging economies are expected to introduce retail CBDCs to enhance payment infrastructure or conduct experiments linking wholesale CBDCs for cross-border payments. Should CBDCs be adopted globally, the speed and scale of international capital movements could increase, potentially amplifying the volatility of capital flows and currency values. In order to ensure the effectiveness of capital flow management policies already in place, it is crucial to foster close cooperation between major central banks on CBDC integration. Moreover, efforts should be made to maximize the benefits of the new payment systems introduced by CBDCs. These efforts include revising financial regulations and upgrading infrastructure by implementing open foreign exchange regulations, maintaining balanced oversight of fintech firms, and enhancing the efficiency of existing payment and settlement infrastructures.

Summary

Policy Study KOR Demographics and Inflation in Korea

This study empirically analyzes Korean data focusing on the impact of the demographic change on the inflation. The analysis indicates that the ongoing aging of the population does not statistically significantly induce inflation in terms of the aggregate price index. However, an analysis of the sub-items of the price index shows that changes in the age composition of the population are associated with sector-specific inflation. Particularly in the service sector, the increase in the population of the young and the elderly appears to have an inflationary effect, while a relative increase in the working-age population seems to be deflationary. In conclusion, this study finds that the relationship between population structure and inflation varies by sector, with a more pronounced correlation in the service sector. This is an analytically significant finding that deserves policy attention. It suggests that policy decisions for price stability should carefully evaluate and distinctively respond to the potential impacts of demographic changes on a sector-by-sector basis.

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Policy Study KOR Inflation Expectations Through the Lens of the Slack in the Real Estate Asset Market

This study examines inflation expectations implied in the real estate asset market. Land is an asset that accounts for more than half of South Korea's national wealth and, like labor, is an essential input factor despite its inelastic supply. Based on this idea, we examine whether a similar regularity as the Phillips curve observed in the labor market is also observed in the real estate asset market. The main results are as follows. First, an increase in the relative price of land can be a pass-through, transferring inflationary pressure over the years. Second, comparing the existing expected inflation indices, an expected inflation rate extracted from the real estate asset market can provide additional information. Third, theoretical analysis shows that the relative price of land and expected inflation can be positively correlated in general equilibrium.

Summary

Policy Study KOR The Impact of External Uncertainty Shocks in Korean Economy

This paper explores the effects of external uncertainty on South Korea’s real economy. By exploiting variations in geopolitical risks posed by Russia and the uncertainty surrounding US monetary policy ― both of which are plausibly exogenous to the Korean economy, the study reveals that such uncertainties negatively impact Korea’s key domestic macroeconomic variables. Notably, this adverse effect is distinctively evident in sectors like exports and manufacturing due to their high sensitivity to external demand dynamics. Using micro-data, the study further indicates that external uncertainty significantly reduces (i) exports to low-income countries and (ii) exports of capital goods. Additionally, the analysis confirms that financial constraints and the irreversibility of investment decisions play pivotal roles in amplifying the effects of external uncertainties.

This study enriches the existing literature by quantifying the impact of external uncertainty using novel instruments ― the geopolitical risk emanating from Russia and the uncertainty surrounding US monetary policy. These findings can offer insights that can guide the formation of resilient policy, aptly designed for a dynamic external landscape, while providing a comprehensive understanding of how external uncertainty influences real economy at both macro and mirco levels.

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Research Monograph KOR Macroeconomic Challenges and Policy Direction for the Post-COVID Era

Korea experienced changes in its economic architecture in the aftermath of two major economic recessions, the Asian Financial Crisis and the Global Financial Crisis. However, triggered by a non-economic factor of infectious disease rather than structural problems of internal and external economies, the COVID-19 crisis unfolded differently from the two previous downturns after 2020. In response, the Korean government carried out aggressive fiscal, monetary, and financial policy measures, together with the early signing of a currency swap agreement with the US. Its quick and decisive actions helped stem capital flight and swiftly stabilized the financial market. Another unique feature of the current crisis is its hugely uneven shocks among economic entities. Notably, the face-to-face service industry had a significant contraction due to its high susceptibility to contracting the virus. Still, asset prices soared even in the pandemic-induced recession thanks to abundant liquidity supplied into the market, widening the gaps in labor and asset income.

Based on the observations, this study intends to analyze the macroeconomic aspects of the ongoing situation and take lessons from it. While investigating the crisis itself, it also attempts to make projections of possible changes in the post-pandemic world and offer policy implications. It first analyzes the pandemic recession on the basis of an economic cycle and identifies what sets this incidence apart from past economic downturns. Then, it turns to the labor market to analyze the impact on jobs and forecast possible structural changes while further examining the features of firms that fared relatively well. Lastly, fiscal and monetary policy measures during the crisis are evaluated to provide implications for the future macroeconomic policy direction.

Summary

Policy Study KOR Decline in the Expected Inflation and the Implications

Using the Phillips curve, this study estimates the long-term expected inflation and the degree of the anchoring of inflation to long-term expectations. The analysis finds that there have been drastic changes in the dynamics of inflation expectations since 2012. Long-term expectations fell to around 1%, hovering below the target. Moreover, inflation expectations are strongly anchored to long-term expectations, implying that the low inflation trend may persist for an extended time. This means that even if inflation rises temporarily, it can fall back to a low level that is short of the target.

Accordingly, support must be provided to stable economic activities while monetary policies are managed in a manner that helps the expected inflation settle within the target range. The monetary authorities need to rigorously analyze the structural changes that may be lying in wait underneath the surface of inflation dynamics, and reexamine the problems within the management system that could impede inflation stability. It is also worth considering a preemptive position when presenting policy directions, which can serve as a reminder of the authority’s strong commitment to inflation stability. Indeed, long-term inflation expectations could close in on the target while inflation settles within the target range when economic agents have a strong belief in this commitment.

Summary

KDI Policy Forum Impact of a Policy Rate Cut on Bank Profitability and Financial Stability

■ Concerns prevail that a policy rate cut could weaken bank profitability and trigger financial instability.

■ However, banks can sustain relatively high net interest margins with little fluctuation despite a rate cut owing to their dominant position in the deposit market and ability to adjust loan maturity.

- By virtue of their market dominance, banks set their deposit rates below the base rate by a fixed percentage, and as such, the former falls within a narrower range than the latter.

- Because deposit rates are little exposed to base rate fluctuations, banks are able to increase their share of long-term loans which are unaffected by short-term rate changes. This means that lending rates also fall by a smaller margin.

- An empirical analysis found that a 1%p change in the call rate, which moves in line with the base rate, adjusts the deposit and lending rates by 0.53%p and 0.58%p, respectively, indicating that the fluctuation (0.05%p) in the net interest margin is statistically insignificant.

■ Therefore, the possibility of financial instability due to a deterioration in bank profitability on a rate cut by the central bank should not be deemed as a constraint.

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