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2011 Jul/12
A Study on Monetary Stabilization Bonds: Issues and Policy Implications
Issue & Policy 11-04
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- Research Topic Capital Markets Financial Services Industry
Cho, Sungwon
- Summary
- Monetary Stabilization Bonds(MSB) issued by the Bank of Korea account for 13% of domestic bond issues and 25% of the total trading volume in the Korean bond market. Central banks in developed countries, however, do not issue securities by themselves but use treasury bonds or bills to implement monetary policy. Korea has been using MSB as a monetary policy instrument because Korea`s continued fiscal surplus hindered the development of the treasury bond market. The increasing volume of outstanding MSB and interest payments, however, raises concerns over the central bank`s balance deficit and its negative effect on open market operations. Coupled with the recent announcement by the government to issue short-term treasury bills in 2012 has prompted debate over whether it is necessary to reduce the outstanding MSB and integrate the two risk-free securities. This paper tries to shed some light on these issues by examining the current trends and key issues related to MSB. The amount of MSB outstanding has increased significantly in recent years due to Korea`s current account surplus and increasing inbound foreign investments. The increase in MSB outstanding pushed up interest payments by the central bank, and it has been a major cause of the central bank`s balance sheet deterioration. The burden of interest payments on outstanding MSB and the upward pressure on the money supply could restrict the effectiveness of the monetary policy. A continuous central bank balance deficit could also lead to an increase in government debt since a MSB is a government guaranteed security. In order to mitigate the problem of large outstanding MSB balance, the idea of integrating MSB and treasury bills has been suggested. Some argue, however, that this is not appropriate because the two securities are different in nature. Integrating MSB into treasury securities can also result in a surge in the current level of government debt. After considering the issues mentioned above, this paper claims that it is more appropriate to gradually reduce the outstanding balance of MSB instead of integrating MSB with the treasury securities. The money raised by issuing short-term treasury bills could be used to repay MSB on maturity. When short-term treasury bills are issued, the central bank could adjust its MSB issues according to the expected treasury bills issues. Essentially, the central bank could secure another monetary policy instrument and improve its balance sheet by reducing the burden of additional MSB issues. Over the long run, as in developed countries, Korea should reduce its dependence on MSB and rely more on treasury securities in implementing monetary policy.