Korea's financial stability-based 'optimal' rate higher than price stability-based one: BOK head
Bank of Korea (BOK) Governor Rhee Chang-yong, left, talks with Swiss National Bank Governing Board Chairman Thomas J. Jordan during the BOK conference at the bank headquarters in Seoul, Thursday. Courtesy of BOK
Korea’s level of neutral rate with financial stability factored in is higher than the level prioritized for price stability, the country’s top monetary policymaker said Thursday.
The neutral rate, widely known as r-star (r*) among central bankers, is a theoretical rate that neither overstimulates nor slows down the economy, enabling an economy to achieve potential growth. This is a state of equilibrium desired by monetary authorities. Central bankers around the globe estimate the rate to determine the adequacy of a country's monetary policy.
Bank of Korea Governor Rhee Chang-yong said the assessment was the finding of comparative studies of r-star estimation models, a topic of vibrant exchanges encouraged to fulfill Korea’s double mandate of financial stability and price stability.
“We always try to get an r-star estimate in consideration of financial stability,” he said during a session of an international conference organized by the BOK. The theme of the two-day conference was "The Evolution of the Natural Interest Rate and Its Implications for the Global Economy."
“We usually find that the level of r-star is slightly above the r-star that was set with only price stability considerations.”
The central bank economists make estimates of the neutral rate in a range. The monetary policy is deemed restrictive if the real rate is above the range and expansionary or accommodative, if below the range.
“We have four or five models of estimating the r-star. Instead of trying to get one policy-relevant r-star level, we use the range and then compare whether our real interest rate is the upper part of the range or the lower part of the range to judge our monetary policy stance.”
The judgment in the validity of r-star is then subject to further cross-checking, as measured by core inflation movements, financial condition index and other indices.
Still, the central bankers continue to grapple with wild fluctuation in variables, a process for greater accuracy enhanced by a comprehensive analysis.
“Whenever we try to introduce some global factors such as exchange rates, current account, capital mobility or movement, we find that the model estimate fluctuates quite a lot,” he said.
“One of our staff will present a model which incorporates external sectors more tomorrow. But the issue is still not resolved and we find that whenever we try to incorporate foreign variables, the estimates change quite a lot which makes it hard for us to use it.”
Swiss National Bank Governing Board Chairman Thomas J. Jordan delivers a keynote speech during the BOK conference at the bank headquarters in Seoul, Thursday. Courtesy of BOK
Prior to the governor’s remarks, Swiss National Bank Governing Board Chairman Thomas J. Jordan gave a keynote speech.
Jordan, who is set to retire after his 16-year stint as the central bank governor, stressed the natural rate is an important reference point for assessing monetary policy but is unobserved and has to be estimated from the data.
“Neglecting r-star estimates in practical monetary policy considerations would be a mistake," he said during the speech entitled: The Natural Rate of Interest (r*) as a Reference Point for Monetary Policy – A Practitioner’s View.
Transforming uncertain model estimates into an r-star measure to make them useful for monetary policymaking is an important task of the Swiss central bankers, he added.
“The policy-relevant r-star estimate plays an important role in our monetary policy decisions. With our risk management approach to monetary policymaking, we ensure that our decisions are appropriate for a range of scenarios.”
A good understanding of the fundamental drivers of r-star is important, he said.
“We draw on work from researchers both at central banks and in academia. I am very much looking forward to interesting presentations and discussions on this highly relevant topic at this conference.”
Topics of the sessions included: Demographics and Real Interest Rates across Countries and Over Time; A Goldilocks Theory of Fiscal Deficits; Determinants of Global Neutral Interest Rates.