A study found that the Conditional Forward Guidance, referred to as the 'Korean dot plot,' affects short-term market interest rates but does not influence long-term rates beyond six months. This means that while forward guidance functions well as a short-term currency policy tool, it has limitations in providing long-term direction.
Generally, forward guidance refers to the Central Bank predicting the future direction of currency policy based on evaluations of future economic conditions. However, the Bank of Korea's adopted 'Conditional Forward Guidance' involves disclosing the opinions of Monetary Policy Committee Commissioners regarding interest rates within the next three months, provided certain conditions are met. It is similar to the U.S. Federal Reserve's dot plot, which aggregates interest rate forecasts from Federal Open Market Committee (FOMC) members, and is also called the 'Korean dot plot.'
◇ Forward guidance, long-term interest rates lose influence after 6 months
According to a report from ChosunBiz on the 15th, Kim Soo-hyun, a professor in the Department of Economics at Jeonnam National University, presented a working paper titled 'Impacts of Conditional Forward Guidance on Interest Rates' at the 'Joint Academic Conference on Economics' held at Han Nam University in Daejeon earlier last month.
Professor Kim analyzed the effects of the Bank of Korea Monetary Policy Committee's policy announcements on short-term and long-term interest rates using a structural vector autoregression (SVAR) model. SVAR is widely used to analyze the impacts of policy actions on the real economy. The research team controlled for the effects of policy shocks on economic growth rates and inflation fluctuations to analyze the impacts of benchmark interest rate decisions on market interest rates.
Additionally, the research team utilized the Korean general natural language processing model KR-BERT to quantify the impact of forward guidance. They first trained the model to classify articles as 'hawkish' or 'dovish' before and after the announcement of currency policy directions, then created a sentiment index indicating the proportion of hawkish statements. They measured changes in the sentiment index three weeks, one week, and three days before and right after the Monetary Policy Committee meeting to quantify the impact of forward guidance.
According to Professor Kim's research, conditional forward guidance was found to influence the flows of call rates, KORIBOR (short-term interbank benchmark rate for 3-month loans), currency stabilization bonds (31 days), Certificates of Deposit (CDs, 91 days), and Commercial Papers (CPs, 91 days).
These results align with findings from last March, when former Bank of Korea Monetary Policy Committee member Seo Young-gyeong analyzed the impact using the Bank for International Settlements (BIS) methodology. At that time, Seo noted that conditional forward guidance had improved predictors and responsiveness regarding the market's three-month benchmark interest rate.
However, this research also revealed limitations of conditional forward guidance. It was analyzed that it did not affect long-term rates beyond six months. This contrasts with major central banks like the Federal Reserve, Bank of Japan (BOJ), and European Central Bank (ECB), which use forward guidance to control long-term rates. For example, the dot plot published by the Federal Reserve indicates the direction for interest rates over the next three years.
Professor Kim explained, "The Bank of Korea's conditional forward guidance is effective for three months, but decisions on interest rates beyond that may change based on announced indicators. Therefore, it obviously cannot affect long-term rates and, at most, has an impact only on short-term rates for the next month, based on the indicators released."
◇ “Long-term interest rates need to be influenced to induce rate cuts”
Opinions regarding these results are mixed. Jo Yong-gu, an analyst at Shinyoung Securities, assessed that the limitations of conditional forward guidance have emerged. He stated, "Short-term rates can be controlled through benchmark rates, so typically, major currency countries adopt forward guidance as a means to adjust long-term rates. The fact that conditional forward guidance only affected short-term rates is likely an unwelcome outcome for the Bank of Korea."
On the other hand, Kim Seong-soo, a senior researcher at Hanwha Investment & Securities, stated that "conditional forward guidance was introduced to provide all market participants with information related to interest rate direction and to eliminate uncertainties regarding currency policy,” and emphasized that its inability to influence long-term rates does not necessarily imply ineffectiveness. He positively assessed that "it seems that the frequency of the market misjudging direction decreased with the addition of forward guidance, after the Monetary Policy Committee meeting."
However, a majority of experts agreed on the need to extend the forecasting range of forward guidance beyond the current three months to increase influence on long-term market interest rates. Park Sang-hyun, a researcher at iM Securities, suggested that "the Korean financial market is heavily influenced by external variables, so the utility of conditional forward guidance, which only reflects rates three months ahead, may not be significant," adding that extending the forecast horizon to six months or a year would enhance reliability.
Professor Kim also advises widening the horizon of forward guidance. He stated, "In the current situation, where the interest rate gap with the U.S. persists, there are burdens in terms of capital outflows and exchange rates to continuously lower interest rates," suggesting that "by broadening the prediction range of forward guidance to form market expectations that interest rates will be kept low in the long term, it would be beneficial for the Bank of Korea to induce effects similar to actual rate cuts."