Economic Survey of Korea 2008: Priorities for Macroeconomic Policy


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The following OECD assessment and recommendations summarise chapter 2 of the Economic Survey of Korea published on 17 December 2008.



…creating a difficult task for macroeconomic policies

Faced with a marked slowdown, the government is implementing a supplementary budget and tax rebates totalling almost 1% of GDP, to be followed by cuts in personal and corporate income tax rates in 2009 10. In November, the government submitted revisions to the 2009 budget proposal, adding further stimulus measures. Concerned about high inflation, the Bank of Korea hiked interest rates by ¼ per cent in August 2008, but then reversed course in October as the global financial crisis worsened, cutting rates by a cumulative 125 basis points by early November. The government announced in October that it would guarantee banks’ foreign borrowing up to a total of $100 billion. In addition, the authorities intervened in the foreign exchange market in July to stabilise the won and arranged a $30 billion currency swap with the US Federal Reserve in October. Between June and October 2008, Korea’s foreign exchange reserves fell by $46 billion, to $212 billion. The won continued to depreciate, falling by 26% in trade-weighted terms between early July and the end of November. Foreign exchange market intervention is likely to be costly and ineffective in the face of global financial turbulence that is driving the won’s depreciation and should therefore be limited to smoothing operations. This would also limit any further decline in foreign exchange reserves, which provide a cushion against Korea’s short-term foreign debt, which soared from $66 billion at the end of 2005 to $189 billion in September 2008.

Foreign exchange reserves and short-term foreign debt

1. Maturity of less than one year.
2. Useable reserves only, i.e. excludes illiquid deposits at offshore Korean banks.
3. For 2008, end of third quarter for foreign exchange reserves and end of second quarter for other data. End of December for preceding years.
Source:  Bank of Korea and Ministry of Strategy and Finance.


Monetary policy faces large challenges

In 2008, inflation significantly exceeded the upper limit of the 2.5% to 3.5% target zone for the first time since the introduction of inflation targeting in 1998. In October, headline consumer prices were up by 4.8% (year-on-year) and core prices (excluding energy and food) by 5.2%, pointing to second-round effects from the commodity price shock. Going forward, with lower commodity prices and slow growth, inflation is projected to fall back within the target zone in the course of 2009. Against this backdrop, monetary policy should for now focus on financial-market stability and supporting activity, until conditions normalise, and then shift its priority to achieving the inflation target. Vigilance is warranted, however, given the sharp depreciation of the won and the fact that the growth slowdown only influences inflation with a sizeable time lag. The course of monetary policy will depend on the extent and duration of the economic downturn, which in turn will be influenced, among other factors, by the amount of fiscal stimulus.

With the strong fiscal position deteriorating…

The implementation of the supplementary budget and tax rebates in the fourth quarter of 2008 may boost output growth by as much as ¼ percentage point in 2009. The budget includes spending to build roads and subsidise utility companies, although this distorts energy prices and encourages excessive consumption. Taking account of the supplementary budget, the central government consolidated budget excluding the social security surplus would record a deficit of around 1½ per cent of GDP in 2008 following a small surplus in 2007. In addition, the stimulus measures planned for the 2009 budget will further boost outlays. It is essential that fiscal stimulus be timely, targeted and temporary. Looking ahead, the government plans to cut personal income tax rates by 2 percentage points by 2010 and the national corporate income tax rate from 25% (close to the OECD average) to 20%. The authorities expect that this will reduce tax revenue by around 2% of GDP. Over the medium term, the priority should be to maintain a strong fiscal position, given future spending pressures associated with population ageing and the development of the social insurance system.

…it is important to restrain the growth of public spending in coming years to prepare for population ageing…

Korea faces a major fiscal challenge with rapid population ageing. The share of the elderly in the population is projected to rise from 10% to 14% by 2018, at which point the working-age population will begin to decline. Korea’s elderly dependency ratio, now the third lowest in the OECD, is expected to be the fourth highest by 2050. The limited coverage of the public pension system, which has levelled off at about one-third of the working-age population, and the low level and duration of contributions, especially among the self-employed, creates concerns. The means-tested benefit introduced in 2008 may need to be expanded to limit poverty among elderly people. In addition, greater economic co-operation with North Korea may boost government spending. Preparing for these future spending pressures requires maintaining the strong fiscal position by achieving a balanced budget, excluding the social security surplus, over the medium term. Given the tax cuts, this calls for reining in government spending, which has risen by 9% per annum (excluding the cost of financial-sector restructuring) since 2002. It is also essential to implement the October 2008 plan to privatise 38 public institutions and abolish three, while merging 38 into 17.


Population ageing in OECD countries
Population aged 65 and over, relative to the population aged 20-64 

 Source: OECD (2006), Society at a Glance: OECD Social Indicators, OECD, Paris.

 Comparison of North and South Korea in 2007



How to obtain this publication                                                                                   

The Policy Brief (pdf format) can be downloaded in English. A Korean version is also available (pdf format). It contains the OECD assessment and recommendations.The complete edition of the Economic survey of Korea 2008 is available from:


Additional information                                                                                                  


For further information please contact the Korea Desk at the OECD Economics Department at  The OECD Secretariat's report was prepared by Randall S. Jones and Masahiko Tsutsumi under the supervision of Vincent Koen. Research assistance was provided by Lutécia Daniel.




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