seong - tae lee : global stagflation threat and monetary policy opening address by mr seong - tae lee, governor and chairman of the bank of korea, at the 16th central banking seminar, seoul, 21 october 2008. * * * opening remarks ladies and gentlemen, let me extend a hearty welcome to all central bankers gathered here from around the world to take part in the bank of korea ’ s “ central banking seminar ”. i would like to express my special thanks as well to our keynote speaker, professor dr. hermann remsperger of the executive board of the deutsche bundesbank. this seminar, now in its sixteenth year, is held to promote exchanges of experience and opinion among the staff of central banks of various countries. we hope as well that it will lead to a consensus among us on major monetary policy issues. at the present time, countries around the world face a very grave situation. economic slowdown and inflation are occurring simultaneously and the worldwide financial turmoil is worsening. in this context the theme of this week's seminar, the " global stagflation threat and monetary policy " merits deep interest and close attention of all central banks. global economy facing triple whammy after enjoying a long period of prosperity under low inflation, the global economy is now experiencing acute difficulties in the three areas of economic activity, prices and finance. the global economy is shrinking fast, led downward by the advanced economies, due to the combined shock of persistently high oil prices and the us subprime mortgage meltdown. emerging economies, too, which had for some time seemingly decoupled from the advanced ones, are now also showing signs of slowdown. what is more, inflation rates around the world continue to run at high levels due to the knockon effects of the sharp rises in prices of international commodities including oil and grains. in the midst of all this, counterparty risks are emerging starkly in the international financial markets and the volatility of price variables such as share prices and exchange rates has grown greatly. a severe credit crunch has thus erupted in response to credit risk reappraisal and the ongoing deleveraging by financial institutions. in consequence, emerging countries now face difficulties in securing foreign currency liquidity, as they are perceived to have relatively higher credit risk. central bank policy tasks ladies and gentlemen, when a cost shock occurs, such as a steep rise in oil prices, it is widely acknowledged that the central bank ’ s policy options are constrained

domestic markets. and, as we have seen during the global crisis, they are thus extremely vulnerable to the impacts of an external shock. looking at the degrees of export dependency ( exports / nominal gdp ) of various major countries in 2008, we see those of the usa and the uk standing at 0. 3 to 0. 7 times the worldwide average, whereas that of korea was 1. 7 times the world average, that of china 1. 2 times, and that of the major five asean members combined 2. 0 times the world average. domestic economic activities in countries with high export dependency of course react very strongly to external demand shocks. empirical analysis shows the usa, the uk and the euro zone exhibiting gdp elasticities of 0. 3 – 0. 4 % to a 1 % increase in external demand ( world gdp minus its own gdp ), in comparison to which korea ’ s is for example about 1. 0 %. 5 asian economies consequently tend to show high degrees of economic volatility. asian economies are in addition at risk of possible financial and foreign exchange market unrest owing to large in - and outflows of global funds. this risk accompanies their pursuit of economic development on the principle of increased market opening and liberalization policies. while causing domestic liquidity to swell, excessive inflows of global funds may at the same time generate steep rises in the prices of assets such as shares, bonds and real estate. in the event of what is termed a sudden stop, i. e. the halting of global fund inflows and their abrupt outflows instead, the domestic financial and foreign exchange markets will be thrown into turmoil. during the global financial crisis, despite holding adequate levels of foreign exchange reserves, a number of asian countries including korea underwent severe crises, due to increased foreign currency liquidity risk and steeply rising exchange rates caused by these sudden fund outflows. apart from this, it must be said that the structures of many asian economies are characterized by fragility, as they are still stuck in the early stages of development. compared to the advanced countries, productivity here is low and the service sector lacking in competitiveness, while the environmental problems arising from our long period of rapid growth until now impose constraints on our abilities to continue growing at reasonable levels in the future. challenges to the further advance of the asian economy transition to a sustainable growth framework the asian economies must move a further step forward if they are to remedy these weaknesses. and as a first step