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Risks of Short-termism in Macro-prudential Policy Making: The Case of Household Debt in Korea

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  • 저자 김영일(金榮一)
  • 발행일 2019/02/19
  • 시리즈 번호 No. 272 (2019-01), eng.
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요약 ■ Korea’s household debt continues to be a major economic risk despite countermeasures, necessitating a thorough overhaul of the current macro-prudential management system.

- The debt expanded to 1,514 trillion won in 3Q 2018 from a decade ago (713 trillion won in 2008), considerably exceeding the income growth during the same period.

- The rapid increase suggests that past policy measures have been ineffective in achieving a soft landing.

- This study adopts a political economy perspective to determine the obstacles to past macroprudential policies, which can be effective tools in terms of credit risk management, and suggests directions for improvement.

■ It was found that the more fixated policy makers are on the short-term gains in growth and employment, the less likely they are to seek macro-prudential policies for financial stability.

- Short election cycles can narrow the horizon of policy decisions, hence policy makers often pursue those with immediate outcomes to earn the public’s favor―even if they entail negative fallouts.

- The failure to implement suitable and timely macro-prudential policies will increase the probability of a credit boom-driven crisis and restrict the scope of mid- to long-term economic policies.

■ To improve the macro-prudential management system, its institutional basis needs to be consolidated to prevent the policy horizon from becoming narrower.

- An institutional mechanism should operate the macro-prudential management system in correspondence with the mid- to long-term preference of the national economy.

- More practical measures should be considered and adopted which could strengthen public accountability and the operational independence of the macro-prudential management system.
요약 영상보고서
Household debt poses a serious risk to the Korean economy.

Advanced economies have shown for the past 130 years that an excessive growth of private loans leads to longer and more severe recessions.

The significance of financial stability has become widely recognized since the global financial crisis, and has led many countries to strengthen their macro-prudential management to avoid excessive loan-taking.

After the global financial crisis, the majority of OECD countries adjusted their household debt ratios.

In Korea, however, household debt has doubled in size, despite the countless warnings and government actions, and the risks are snowballing.

So, why have past policies failed to contain the situation?

Macro-prudential policies can enhance social welfare through financial stability, but this requires a long-term effort.

And because the policies restrict excessive amount of loans to reduce the risks of financial instability, it is difficult to gain public support during recessionary periods when production and employment are low.

They also generate resistance from interest groups due to their impact on the loan and real estate markets.

It may be theoretically shown that, the more policy makers are fixated on the short-term outcomes, the more likely they are to choose stimulus packages that entail excessive debt, despite their concerns over financial instability.

On the other hand, those who prioritize long-term gains will select macro-prudential policies that sustain financial stability rather than short-term stimulation of the domestic demand.

The pursuit of short-term gains is exacerbated by Korea’s short election cycles, with important elections occurring every one to two years.

In fact, after the global financial crisis, decision-makers ignored the warning signs about the state of household loans, and adopted not only monetary and fiscal policies but also stimulus measures that would ease loan regulations in the hopes of reviving the economy in 2014.

Given the high preference for short-term results, it would be difficult to effectively pursue macro-prudential policies to achieve financial stability.

(Interview with the author)
In order to improve the macro-prudential management system,
institutional mechanisms must be put into place to prevent the horizon of decision-makers from narrowing. In the UK, the central bank is guaranteed independence as the enforcer of macro-prudential policies which deters tendencies to focus on the short-term gains. In the case of Australia and Canada, a separate financial supervisory institution implements such policies with the openness and transparency of the decision-making process. Taking a cue from these countries, the independence and accountability of the institution that implement macro-prudential policies in Korea must be strengthened by guaranteeing tenure and adopting an evaluation and compensation system for top decision-makers to encourage them to pursue the longer-term benefits.
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