Analysis from the Bank of Korea suggests that population aging could exert downward pressure on growth rates and real interest rates, thereby reducing the leeway of currency policy. The Bank of Korea advised strengthening the real and basic economic structure through structural reform and refining the operation of policy tools to fit the changed conditions.
On the 4th, the Economic Research Institute of the Bank of Korea released a report titled 'Super-Aging and Currency Policy,' containing this analysis. This report was included in last month's Economic Outlook Report published by the Bank of Korea and involved Jaewon Lee, the head of the Economic Research Institute, and Indoh Hwang, the head of the Financial Currency Research Office.
According to the research team, Korea entered a super-aged society at the end of last year with a population ratio of individuals aged 65 and older exceeding 20%. By 2045, Korea is expected to surpass Japan, recording the highest proportion of elderly population among Organization for Economic Cooperation and Development (OECD) countries.
Aging reduces labor input, leading to a decline in growth rates, while lowering the marginal productivity of capital, which reduces real interest rates. The research team's analysis, based on an open economy life-cycle model, indicated that aging led to a drop in the equilibrium real interest rate by approximately 1.4 percentage points compared to 1991.
The research team analyzed the trends of growth rates and real interest rates based on three scenarios: ▲ an increase in birth rates ▲ expanded employment for the elderly ▲ and improvement in total factor productivity (TFP) due to technological advancement. First, if the birth rate gradually recovers to the OECD average and increases to 1.58 by 2035, the growth rate around 2070 is expected to rise by 0.7 percentage points and the real interest rate by 0.2 percentage points.
An increase in employment among the elderly had a more immediate impact on growth rates and real interest rates. If the employment period extends by five more years by 2029, the growth rate for that year is estimated to rise by 1.6 percentage points, and the real interest rate by 0.2 percentage points. However, as the effect of labor force growth wanes, the growth rate declined again.
Even when productivity improves through technological innovation, both the growth rate and real interest rate rose. If Korea's TFP growth rate is 0.5 percentage points higher annually between 2025 and 2070, the growth rate rose by 0.7 percentage points, and the real interest rate by 0.2 percentage points.
The research team also analyzed the impact of aging on the Bank of Korea's dual mandate of price and financial stability. Based on OECD data, the team found that demographic changes are expected to lower the average annual inflation rate by 0.15 percentage points over the next 45 years (2025-2070). Furthermore, as aging intensifies, the income growth rate per capita, real interest rate, and dwelling price inflation rate all declined.
The research team noted, "Aging can negatively affect the profitability of financial institutions through weaker repayment capacity of borrowers, reduced interest margins, and declining collateral asset values," adding, "These changes could ultimately undermine the capital adequacy of financial institutions, increasing the risk of defaults."
The research team emphasized the urgency of structural reforms based on these findings. Specifically, the team advised pursuing policies such as ▲ expanding employment for women, the elderly, and foreigners ▲ expanding quality jobs, stabilizing the dwellings market, and enhancing childcare infrastructure ▲ and supporting and encouraging technological innovation.
The research team indicated, "If these policies are pursued comprehensively, it will be possible to alleviate structural constraints arising from aging and to lay the foundation for the growth of our economy," adding, "If birth rates and productivity increase and elderly employment expands, real interest rates and growth rates are expected to rise by an average of about 1 percentage point from 2025 to 2070."