Shin Hyun-song, the nominee for Bank of Korea (BOK) governor, on Saturday identified the Middle East crisis as the greatest short-term risk to the Korean economy and signaled his intention to pursue flexible monetary policy. Asked about his reputation as a "pragmatic hawk," Shin drew a line. "I will read the overall economic trend carefully, understand how the financial system and the real economy interact, and then respond flexibly to circumstances," he said. While his remarks were close to a statement of principle, markets interpreted them as more growth-friendly than expected. Shin also assessed the government's supplementary budget positively. "The Middle East situation is compounding difficulties for vulnerable sectors, so policy easing is necessary," he said. The comment suggests close policy coordination with the government is in store.
Shin will very likely confront the conflicting policy objectives of price stability and economic defense as soon as he takes office. On Saturday, the government unveiled a 26.2 trillion won supplementary budget to counter the Middle East-driven shock. This emergency prescription is unavoidable to a degree. The prolonged Iran conflict has pushed domestic refiners into a management crisis, and key manufacturing sectors including semiconductors and automobiles could suffer broader damage. The concern is that cash-disbursement spending in the supplementary budget may stoke inflation amid the double shock of high oil prices and a weak won. The won-dollar exchange rate breached the 1,530 won level on Saturday for the first time since the global financial crisis. Stagflation — rising prices amid an economic downturn — could become reality. If inflation fears intensify, the BOK may be forced to raise interest rates even as the economy slows.
Now more than ever, a precisely calibrated combination of fiscal and monetary policy is essential. Shin must keep in mind that the BOK's founding mandate is "price and financial stability." Preemptively addressing financial instability risks through a series of macro-stability measures and clear market communication is also a critical task. Even as the government expands fiscal spending, it should ease inflationary pressure through targeted support for energy costs and vulnerable groups. Wisdom is also required to turn this crisis into an opportunity for diversifying energy supply lines and restructuring the manufacturing sector. It goes without saying that strengthening the economy's fundamentals through deregulation and the cultivation of new growth engines remains the ultimate remedy.