Opening Address
June 2, 2022
Chang Yong Rhee
Governor, Bank of Korea
Ladies and gentlemen,
I am truly delighted to welcome everyone participating in this year's
Bank of Korea International Conference. It means a great deal to us to
host this conference once again after being suspended because of
COVID-19.
I would like to start with a few words of gratitude. First, I would like
to express my sincere appreciation to our two keynote speakers,
Professor Robert Townsend and Dr Hyun Song Shin, as well as to all
of the moderators, speakers and discussants. As in past years, the
organizers have brought together a very impressive list of participants
who have made important contributions over the years helping the
profession improve the art of monetary policymaking. I would
particularly like to express my deepest gratitude to Professor Thomas
Sargent for all of his guidance and support in organizing this year's
conference. Most importantly, I want to assure him that we have all
gone back and reread his JMCB paper published in 1971 on the
"Accelerationist" controversy.1) Some might correctly argue that his work
along with Milton Freedman's 1968 Presidential Address to the AEA
should have provided ample analytical firepower and warning to prevent
the Great Inflation of the 1970s.2) They can certainly help us avoid
making a similar mistake today.
The theme of this year's conference, "The Changing Role of Central
Banks," is very timely and important for several reasons. After two
decades of low inflation and anemic growth and working hard to fully
recover from the global financial crisis (GFC), policymakers were faced
with an unprecedented health crisis. Initially, in many countries this
resulted in aggregate demand falling roughly in tandem with aggregate
supply. The large reduction in the demand for oil resulted in a collapse
in oil prices that initially pushed inflation lower. But the reopening
phase has been much more problematic as a bounce back in aggregate
demand has stretched capacity in several sectors. Over the last few
months, there is now clear evidence that underlying inflation and
long-term inflation expectations have ratcheted upwards to levels in
some countries that are well above their stated objectives.
Many commentators are predicting a recession, while others suggest we
might still have a smooth landing without a series of large interest rate
hikes. Today, I look forward to learning from your insights and wisdom
regarding what central bankers can do in the short run to deal with
different scenarios and narratives as they evolve, but to also reflecting
upon how central banks could develop richer analytical frameworks to
support monetary policy making under uncertainty. I will be happy to
learn more about your views on what you think are the key risks on
the horizon and any ideas that you might have to help deal with
mitigating the implications of these risks.
Historically, the role of central banks has changed when faced with
major economic and financial crises.3) The Great Depression in the
1930s served to highlight the macroeconomic stabilization function of
monetary policy. The 1970s oil shocks and the ensuing experience of
the Great Inflation firmly established price stability as the primary
objective of central banks. Their role as inflation fighters was further
entrenched as they gained public trust and secured independence from
the government.
After the GFC, while the financial stability role of central banks was
emphasized, growing calls were also made on them to conduct monetary
policy with a greater weight on employment and growth. As the
Occupy Wall Street movement showed us, the Great Recession and the
consequent employment slowdown and widening income gap led to
criticism of central banks along with voices calling for their social
responsibility. Meanwhile, persistently below-target inflation eroded the
credibility of inflation targeting as a framework for monetary policy,
and when policy rates reached the effective zero lower bound, central
banks had to resort to quantitative easing and other unconventional
monetary policy (UMP) tools.4)
In the aftermath of the COVID-19 crisis, as economic polarization
deepened and transformation to a digital and green economy accelerated,
the perceived scope of the central bank's role has further broadened.
Against this backdrop, central bankers started to publicly emphasize
collaboration on a full range of economic policies-not only monetary
policy but also fiscal and structural policies-in a comprehensive,
consistent and coordinated manner.
What we now find, however, is that the central bank's role that has
changed with the times stands at another crossroads. With the return of
1970s-style inflation for a variety of reasons-expansionary fiscal policy,
low interest rates and UMPs, and supply bottlenecks resulting from the
pandemic and the war in Ukraine-we must yet again rethink the role
of central banks.5)
Under these circumstances, we cannot but reflect on how the role of
central banks should adapt. Let me start by asking a few questions. The
first is, do the current economic conditions simply call for central banks
to revert to the past? In other words, as in the pre-GFC days, should
they focus on the primary objective of maintaining price stability? My
second question is, once this current inflation eases, will we see a
return to the pre-COVID trend of low growth and low inflation? And if
so, should central banks use the same tools mobilized over the last ten
years? Or should they recalibrate them or develop a new set of tools
accounting for the current episode of unexpected high inflation?
The first question, perhaps, might be easy to answer in the context of
emerging topics such as digital innovation and climate change. Coping
with them is unavoidable, and the role of central banks in these areas
can only grow even larger going forward. In recognition of this, central
banks around the world are at present either working to introduce
CBDCs or accelerating research; for green growth as well, they are
drawing concrete plans to develop and implement policy tools.
Calls for the social responsibility of central banks are also likely to
continue. This is because the shock from the pandemic and the
subsequent recovery turned out to be uneven across income groups and
industrial sectors.6) This trend of polarization is likely to deepen in a
high inflation environment. And, given the negative perception of the
UMP tools mobilized by central banks over the past ten plus years and
the consequent rise in asset prices, there are growing voices calling on
central banks to fulfill their social responsibility by cleaning up the
mess they might have created. However, I do not know how effective
existing monetary policy tools would be in addressing the challenges
associated with income polarization or asymmetric sectoral shocks.
As for the second question-whether secular stagnation will return once
the current inflation episode cools off, and if so, whether central banks
could use the same set of tools mobilized as before-there is not much
I can say with certainty at this point. But I think the chance of
returning to a very low inflation and low growth environment again is
significant for advanced economies and some emerging market
economies (EMEs), at least for Korea, Thailand and maybe China
considering their rapid aging problem. To escape a low growth, low
inflation trap, should EMEs or Korea for that matter follow the same
advice Professor Paul Krugman gave to central bankers in advanced
economies, to "credibly promise to be irresponsible?"7) A look into the
actual changes in the size of central bank balance sheets in the last
decade indicates that EME central bankers may not have the luxury to
do so.
The G7 economy central bank balance sheets saw a large increase from
3.8% relative to GDP to 31.0% over the 2007 to 2020 period. But
EMEs saw a limited increase from 4.0% to 6.2%, though the increase
was still historically high by EME standards.8) I would attribute this,
first of all, to the fact that, after the GFC, EMEs had relatively less
severe economic downturns than advanced economies. But the fact that
EMEs are not key convertible currency issuers is an important constraint
and they could not afford to deploy expansionary fiscal and monetary
policies at will. The same use of UMP tools as in advanced economies,
with the slightest misstep, could have led to expectations for currency
depreciation and raised the likelihood of capital outflows. Credibility
constraints were inevitably much more binding in anchoring inflation
expectations relative to advanced economies. In the conduct of monetary
policy, therefore, EMEs had no other choice but to act in a more
prudent and conservative manner.
As a result, compared with their historic average, inflation in EMEs has
not reached the high levels advanced economies currently face, but this
should be no reason to feel relieved about the future. I think EME
central banks' effective use of asset purchase programs in the last
decade-as seen in the avoidance of significant currency depreciation
and capital outflows despite their own massive expansionary monetary
and fiscal policies, in some cases defying the taboo of buying
government debt in the primary market-was possible mainly because
they were implemented in response to common global shocks such as
the GFC and COVID-19. Abundant global liquidity and the fact that
advanced economies themselves were breaking taboos on a much larger
scale might have helped EMEs avoid being penalized by international
capital markets, unlike in the past.
In the future, when EMEs alone face the risk of falling into secular
stagnation, I doubt whether the same result will hold. A similar
magnitude of expansionary fiscal and monetary policies in EMEs as
seen in the last few years in coping with COVID-19 would, in the
absence of massive global liquidity, have different implications for
exchange rates, capital flows and inflation expectations. What effective
EME-specific unconventional polices could be designed for their own
periods of low inflation and low growth is still an open question, and
this will be my homework to get prepared for the future. This could
also serve as an opportunity to discuss the topics of how QEs can
distort term premiums and other aspects of financial markets, and
whether EMEs can look to other effective UMPs such as FX
interventions and capital flow management measures to achieve their
objectives.
Distinguished guests,
Central banks are like an organism that evolves over time. The more
than 300 years of central bank history have been an incessant process
of evolution. We must not forget that the interpretation of central bank
mandates and ways to achieve them have been constantly evolving.
Hopefully, this Conference will be useful in sharing our thoughts on the
challenges that lie ahead so that central banks can live up to social
expectations during this great transformation to a post-pandemic world. I
look forward to hearing a rich discussion from diverse perspectives
today. Once again, I wish all of you a fruitful and successful
Conference.
Thank you.
2 June 2022
Governor
RHEE, Chang Yong
References
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Friedman, M., 1986. "The Role of Monetary Policy," Presidential
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