Bank of Korea Governor Hyun Song Shin said government fiscal expansion and central bank monetary tightening do not necessarily conflict. If fiscal spending goes beyond a short-term boost to demand and translates into higher productivity and potential growth, it can instead complement monetary policy, he said.
Speaking at a press conference on the 27th after the central bank raised its base rate by 0.25 percentage point to 3% from 2.75%, the governor said, "If fiscal spending is applied to investment that can lift future growth and raises potential growth, it may not necessarily be out of step." He added, "It could even work in a direction that helps monetary policy." He said, "The answer seems to be determined by the form, scale and use of fiscal spending," indicating he would watch how the budget is executed.
The remarks came as the central bank sharply raised its growth outlook for South Korea. In its August economic outlook released the same day, the Bank of Korea lifted this year's growth forecast to 3.3% from 2.6%, an increase of 0.7 percentage point, and next year's to 2.9% from 2.1%, up 0.8 percentage point. Strength in the semiconductor cycle driven by expanding artificial intelligence infrastructure investment led the upgrade, while the bank also projected that a recovery in consumption on improving incomes and wider investment would support growth.
Against that backdrop, the government's expansionary fiscal stance is a double-edged variable for the central bank. Budget execution can raise demand for construction, equipment and labor, adding to price pressure in the short term.
Choi Nam-jin, a professor of economics and finance at Wonkwang University, said, "The governor was explaining in a roundabout way that fiscal and monetary policy should be judged separately." He said the point was that "if fiscal spending leads to higher productivity and higher potential growth, the resulting rise in growth is hard to see as necessarily out of step with the current tightening." Still, the professor noted that whether fiscal spending actually leads to productivity gains is a separate question.
With growth stronger than expected, the assessment of prices has also shifted. The governor said, "The point at which the gross domestic product gap turns positive will be pulled forward to this year from next year, earlier than initially expected," adding, "It is already almost at the threshold." The GDP gap is an indicator of how far actual output exceeds an economy's normal production capacity. When growth runs above the level of potential growth, demand can rise faster than supply and price pressure can build.
The central bank accordingly raised its forecast for core inflation to 2.5% this year from 2.4%, and to 2.5% next year from 2.3%. A 15.6% year-on-year rise in gross domestic income in the second quarter was another factor the bank cited behind price gains. The governor called the figure "unprecedented."
