Essays on Household Debt, Macroprudential Policy and Monetary Policy in South Korea

Abstract

Household debt in South Korea is high and still rising. Household debt to GDP ratio had risen at the similar pace with that in the US until 2007 but it has still been rising whereas it has been falling since 2017 in the US. As a result, it is now higher in South Korea than in the US. There was a dramatic growth in household debt in the US preceding the recent Great Recession and high level of household debt was viewed to amplify the severity of economic recession in the US constraining consumer spending. In this context, high and continuously rising household debt could be a potential risk factor for the South Korean economy. Macroprudential policy, which indicates policy aims to reduce financial systemic risk pre-emptively, is a crucial measure to slow down the pace of household debt growth in South Korea. However, there is no established tool to analyse or evaluate its effects and relationship to monetary policy. The second chapter presents the trend and distribution of household debt in South Korea, and brief history of policy responses to continuously increasing household debt. The third chapter shows how macroprudential policy works by using a simple heterogeneous DSGE model with collateral constraint. The model is based on so-called borrower-saver model. Despite of its simplicity, the model can clearly explain how macroprudential policy affects household debt and related variables in South Korea. In addition, dynamics of this model imply increasing amortisation rate is superior measure to decreasing LTV ratio because it induces less volatility in economy. The collateral constraint in this thesis is designed to distinguish household debt (stock) and borrowing (flow). As a result, it is more realistic than the one mostly used in literature. This collateral constraint setting contributes to the better results especially when we analyse the phase of tightening household credit conditions. Furthermore, it enables us to see how amortization rate affects the South Korean economy. The fourth chapter extends the model mainly to see how credit tightening and monetary policy work differently and how they interact. Habit formation in non-durable good consumption, price rigidity in non-durable good producers, fixed cost in intermediate good production and monetary policy are added in the model. Not only the newly added elements themselves but also inflation make model's responses different from those in the previous chapter. Nominal and real rigidities make dynamics last longer and more realistic. Due to the structure of collateral constraint, a rise in inflation can reduce the level of real household debt whereas there is no inflation effect on real household debt with the common type of collateral constraint. This also influences responses to monetary policy shock. The results demonstrate credit tightening is better than monetary policy in slowing down the growth rate of household debt. Among all policy measures considered, decreasing amortization rate is the most effective and increasing LTV ratio is the second. These implies that ongoing policy efforts to slow down the growth rate of household debt in South Korea is on the right track. The fifth chapter shows welfare effects of macroprudential policy. The results illustrate it is impossible to get social welfare gains in a situation given in South Korea when discretionary macroprudential policy comes into effect. If government adopts countercyclical macroprudential rule, it is possible to improve social welfare but it requires welfare loss either of borrower or saver.