Two-speed recovery and what it implies for

By Kim Jae-chun, deputy governor of Bank of Korea

Recently, there have been many changes taking place in economic conditions at home and abroad amid mounting uncertainty _ the strengthening of the momentum toward a US economic recovery, international oil price hikes and economic fallout from the Japanese earthquake.

The Bank of Korea (BOK) a few days ago announced a revision of its economic outlook for this year, taking these changes into account.

The growth rate of the economy this year is not thought to vary significantly from last December's forecast of 4.5 percent. While improved conditions for the U.S. economy act as a factor in pushing up Korean GDP growth, the sharp run-up in oil prices serves as a negative factor, pulling down the growth rate.

And if the impact of the Japanese earthquake and nuclear disaster becomes prolonged, the negative effects will be greater.

As for consumer price inflation, its rate is now forecast to come close to 4 percent, the upper limit of the BOK’s inflation target, influenced largely by the steep rise in oil prices.

To make matters worse, since it is difficult to foresee oil prices falling significantly in the near-term, and given, for example, the demand pressures arising from the economic upswing and the second round effects of rising expected inflation, we cannot rule out the possibility of prices remaining elevated for some considerable time to come.

What this revised outlook suggests is that the scenario of a two-speed global recovery is materializing, under which advanced countries continue their accommodative monetary policy to cope with only a modest rise in activity and sovereign debt overhang, while emerging market economies run the risk of high inflation and asset price bubbles.

The IMF and other international institutions recommend that these countries facing the major challenge of stabilizing the economy in a two-speed global recovery make use of a policy mix that combines interest rate hikes and macro-prudential regulations.

In contrast to some other emerging market countries, asset price bubbles are not a serious problem for the Korean economy and maintaining price stability is the highest priority issue at the moment.

To make adequate decisions in achieving this goal, policy-makers should take into account changes in external conditions as well as the financial and foreign exchange markets.

Apart from this, some argue that we should keep interest rates low in consideration of low-income households and small and medium-sized enterprises suffering from a debt burden.

Others maintain that the current negative real rate of return makes it harder for retirees and others to live off their interest income.

Decisions on interest rates affect every group throughout society and so monetary policy should be framed from a macroeconomic perspective.

Even though some worry about the negative effects of anti-inflation policies, I believe that the Korean economy has the capacity to fully absorb the shock they present, being backed by the sustained strong growth momentum of the private sector.

What is more, Korea’s fiscal health is in good shape compared to some other countries and the soundness of its financial companies and foreign exchange sector is greatly improved as well. Simply put, we can say that the Korean economy is sufficiently well-placed to tackle the tasks confronting it through appropriate macroeconomic management and to sustain stable growth.

Having said that, international policy cooperation is also very important for the Korean economy to overcome the present challenges it faces—for the issues confronting it as a small open economy are rooted to a considerable degree in its structural sensitivity to changes in international commodity prices, global capital flows and relative exchange values of currencies.

Korea must therefore take an active part in discussions on moderating the volatility of international commodity prices, reforming the international monetary system, improving the functions of global financial safety nets and other major matters now being pursued under the G20 agenda, and strive for the position of emerging market economies to be properly reflected.