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보고서 1
Need and Directions for Reform of the Foreign Exchange Transactions Act [22-20]
Senior Research Fellow LEE, Seungho / Oct. 24, 2022
The Foreign Exchange Transactions Act (the “Act”) was enacted in 1999 immediately after the Asian financial crisis, aiming for freeing up foreign exchange transactions and invigorating market functions. Contrary to its purpose, the Act has been used to adjust and manage the foreign exchange sector to implicitly curb the outflow of foreign capital and ease excessive foreign exchange rate volatility over the past two decades. This has been inevitable to some extent because the prolonged external uncertainty has made external stability a top priority in the aftermath of the 2008 global financial crisis.     

As a result, policy measures implemented in the era of the lack of foreign exchange still underpin the fundamentals of the Act, including prior reporting of capital transactions, procedural restrictions on international payment and receipts, and foreign exchange agencies. These measures cause the inconvenience that outweighs the benefits of contributing to external soundness, run counter to the liberalization of foreign exchange transactions and invigoration of market functions, and undermine crisis response capabilities and balanced development of the entire financial industry. Notably, Korea has experienced macroeconomic changes, transforming from a foreign exchange-deficit nation to a capital exporter. In addition, its competence in dealing with a crisis has improved immensely and it has seen non-banking financial institutions gaining importance due to the rise in overseas financial investments. Against this backdrop, the Korean government should gear the reform of the Act towards the following directions.     

First, the new Foreign Exchange Transactions Act should focus on mitigating public inconvenience and facilitating freer foreign exchange transactions. To this end, the government should overhaul the relevant legal system and free up transactions by abolishing the prior reporting of capital transactions. Second, it is necessary to address the bank-centered foreign exchange agency system and the procedural regulation that requires international payment to go through a bank. With these measures, the government needs to allow other financial institutions including financial investment firms to freely engage in foreign exchange-related business, which can contribute to balanced development in foreign exchange business competence of the entire financial industry and help maintain external soundness. Third, the new Act should be designed to stimulate the economy under the open economic system. In preparation for population aging, investment conditions should be improved further to ensure that overseas financial investments by residents lead to a stable stream of national disposable income.      

The reform of the Act could structurally reinforce Korea’s external soundness under the new macroeconomic environment and hence, enhance Korea’s capability to cope with external shocks. In this respect, a prudent approach is needed for the reform, regardless of destabilizing factors in the domestic and global financial markets. 
보고서 1
Determinants and Implications of Korea’s Inflation [22-19]
Senior Research Fellow JANG, GEUNHYUK and others / Oct. 17, 2022
Soaring inflation in major economies as well as in Korea has hit economic players hard. Global economic conditions such as supply chain disruptions and rising commodity prices are recognized as the main driver of the current inflation cycle, and demand recovery observed in each country is aggravating inflationary pressure. This article explores the determinants and characteristics of Korea’s inflation by comparing inflation factors between the US and Korea.  

It has been found that commodity prices affect Korea’s inflation most and that the global supply chain crunch has the same critical influence as the won-dollar exchange rate. Notably, the pressure on the demand side has worsened inflation in the US, whereas it hardly has had any significant impact on prices in Korea. This can be attributable to Korea’s structurally sluggish domestic consumption. As of the second quarter of 2022, about 60% of price increases in Korea (consumer price index, on a QoQ basis) came from global factors such as the rise in commodity prices (40%) and the supply chain crisis (20%), while the proportion of demand pressure remained at a meager 1%. In addition, the won-dollar exchange rate made a considerable contribution, representing 11% of entire inflation factors.  

As the main drivers of domestic inflation are global factors, Korea’s authorities face difficulties in implementing policies. The upward trend of expected inflation starting this year and the recent instability in the won-dollar exchange rate require monetary tightening. However, it is necessary to consider that demand-side pressure makes a marginal contribution to price hikes. Other policies need to be aligned with monetary policy. On top of that, recent history has shown that comprehensive energy policies including oil tax reduction are less effective in the medium to long term. Accordingly, policy responses to rising energy prices should focus on supporting low-income households.  

 The current uptrend in inflation could be eased on the back of tightening policies around the globe. But there is a possibility that higher commodity prices and supply chain disruptions would be entrenched as structural factors that can escalate global inflation uncertainties, due to the prolonged pandemic crisis, intensifying geopolitical conflicts and accelerated responses to climate change. Considering recent higher inflation, central banks’ effort to adjust the aggregate demand is of importance in inflation stabilization, which should be coupled with policy measures to tackle the intensifying and prolonged inflation uncertainty arising from structural factors.
보고서 1
Global Monetary Policy Divergence: Impacts on Korea’s Capital Flow and its Implications [22-09]
Research Fellow Kim, Hansoo / Jun. 30, 2022
Amid signs of recovery in the real economy and higher inflation, major economies have increasingly taken different approaches to monetary policy. Starting this year, the US and the UK are tightening monetary policy at a faster pace while Europe and Japan maintain the expansionary monetary policy stance. Such divergence between advanced economies can be commonly observed in the two rate hike cycles of the US during the early 2000s. It has been found that in the previous rate hikes, the adverse effects such as abrupt capital outflows from emerging markets were only limited.        

Korea has also seen the negative impact arising from monetary tightening of the US diminishing since the global financial crisis. According to the empirical analysis conducted by this article, monetary policy divergence between major economies plays a significant role in partially offsetting the effects of the US rate hikes on the overall capital flows in Korea. The analysis implies that if the monetary policy decoupling continues, greater external uncertainties such as accelerated monetary tightening by the US would have only a limited impact. However, considering that existing risk factors were unprecedented in the previous rate hike cycles of the US, it is advised against an optimistic outlook that the negative effects of rate hikes would be extremely limited.  

Korea has recorded a current account surplus and tightened its FX soundness regulation, which has made its economic fundamentals stronger enough to respond to instability in the global financial market. Still, however, greater external uncertainties serve as major factors behind sudden capital flows in Korea and other emerging economies, which requires extra caution. More recently, a prolonged geopolitical conflict and a delayed recovery in global supply chains are raising the possibility that inflation would become entrenched. Accordingly, thorough preparation should be made to deal with various risk factors such as simultaneous monetary tightening implemented by central banks of advanced economies.  
보고서 1
Assessment of the Fed’s Monetary Policy and its Implications for Interest Rates in Korea [22-08]
Senior Research Fellow Baek, In Seok and others / Jun. 13, 2022
As the US has entered a rate hike cycle, there are growing concerns about the path of the Fed fund’s rate and its implications. Against this backdrop, this article analyzes the direction of US monetary policy and its risks, and explores how it would affect Korea’s financial market, especially market interest rates.

According to an analysis of US rate hike cycles since the 1970s, inflation tends to accelerate when the policy rate remains lower than the neutral rate of interest. This indicates that with the policy rate being around the neutral rate, it would be difficult to stabilize prices during the current rate hike cycle. Furthermore, even if the policy rate is pushed higher than the neutral rate, a much tighter monetary policy would be required considering the state of inflation at hand. In particular, given the late response of the Fed, unless inflation is curbed shortly by external drivers, the Fed is likely to lift interest rates well over the levels of the neutral rate. It will probably lead to the recurrence of monetary policy shocks.

If the Fed’s tightening is stronger than expected, it would transmit the shock to Korea’s financial market in the short run. The analysis has found that the Fed’s rate hike shock raises long end yields of Korea Treasury Bonds (KTBs) higher, influencing other market interest rates as well. Furthermore, it drives up the interest rates of corporate bonds and increases financing costs of banks, thereby pushing up the loan interest rate of households. 

On top of that, prolonged tightening by the Fed could trigger an inversion in short-term government bond yields as well as policy rates between Korea and US. However, given the propensity of foreign investors, the gap in interest rates between the two countries is unlikely to have a significant effect on the overall capital flows. But it is worth noting that if the Fed’s tightening is added to growing downside risks to growth, it could escalate adverse effects, which requires extra caution. 

The Fed’s tightening shock would aggravate the burden of financing on each economic player. This may require domestic policy responses, such as the purchase of KTBs and provision of liquidity, to cushion the blow. In addition, it is necessary to devise effective countermeasures by closely monitoring risks in the financial market and the possibility of such risks transmitting to the real economy.