These days, many readers of BoK reports will often come across the term “structural reform”.
As is well known, structural reform is an essential means to strengthen an economy’s fundamentals. That is why major central banks, including the Bank of Korea, have continued to study changes in economic structures and institutions.
But that is not the only reason the Bank of Korea emphasizes structural reform. It is because structural reform is a prerequisite for monetary policy to function effectively. Monetary policy faces significant constraints and diminished effectiveness without adequate structural reforms. In other words, structural reform helps make room for monetary policy to function.
If the economy’s fundamentals weaken further, the damage will be severe. Structural reform is the way forward.
Let’s begin by talking about the fundamentals. One of the most pressing concerns Korean economy is facing is low growth. At times like this, it is important to distinguish between a short-term economic downturn and a structural slowdown in growth.
Nobel laureate Robert E. Lucas Jr. once said: “The consequences for human welfare involved in questions like these(regarding long-run economic growth) are simply staggering: Once one starts to think about them, it is hard to think about anything else.” — Lucas, 〈On the Mechanics of Economic Development〉, 1988
He stressed that designing a long-term growth framework and restoring growth potential is far more important than short-term countercyclical measures.
A recession can be addressed to some extent with policy tools such as interest rate cuts. However, structural problems that weaken the economy’s fundamentals cannot be solved by such temporary measures. In fact, in the early 2010s, Japan implemented Abenomics, flooding the economy with liquidity and lowering interest rates, but failed to restore its already weakened fundamentals. This case illustrates a key lesson: monetary policy alone cannot revive the foundation for growth. (BOK Issue Note No. 2025-14, “Lessons from Japan’s Economy”)
Korea’s situation is also far from easy. The fertility rate remains at 0.7, the lowest in the world, and since the end of 2024, the share of the population aged 65 or older has exceeded 20%, marking the country’s entry into a “super-aged society.” [Figure 1-2] These demographic changes are rapidly eroding the economy’s fundamentals. It’s like a car whose engine is cooling down: no matter how much fuel (liquidity) you pour in, the car won’t move forward if if the engine (growth engine) has cooled.
This is why structural reform is urgently needed now. Changes such as restoring the birth rate, expanding employment opportunities for older workers, and boosting productivity through technological innovation are the key to rebuilding the economy’s fundamentals.
If we ignore structural problems and rely solely on short-term fixes, we may only end up amplifying side effects such as rising inflation, increasing debt, housing price bubbles, and greater exchange rate volatility. This is precisely why the Bank of Korea continues to stress the need for structural reform.
Without structural reform, monetary policy cannot breathe
Another reason the Bank of Korea emphasizes structural reform is that it is essential for the central bank to fulfill its core mandates—price stability and financial stability.
(1) Declining room for interest rate cuts
One of the most pressing structural challenges facing our economy is low fertility and population aging. These demographic changes are acting to steadily lower the ‘equilibrium real interest rate’ (Hwang, Lee, and Park, 2025).
What happens when the equilibrium interest rate falls structurally? The central bank’s ability to cut interest rates in response to crises becomes limited. Even a small reduction in the policy rate quickly brings it close to the zero lower bound. In other words, even without considering other structural factors, the policy space available to respond to temporary economic slowdowns is shrinking.
Indeed, according to the Bank of Korea’s Economic Outlook Report – Chapter 3 In-depth Study: Changes in Monetary Policy Conditions in a Super-Aged Society and Their Implications (June 2025) , the real interest rate in 2024 is estimated to have fallen by about 1.4 percentage points due to low fertility and population aging. [Figure 3]his downward trend is expected to continue. However, the report adds that structural reforms—such as improving productivity or reversing the decline in the birth rate—could help mitigate this fall in the real interest rate to some extent. [Figure 4]
So why do low fertility and population aging structurally push down the equilibrium interest rate? In a super-aged society, the economy’s growth engine weakens, leading to reduced investment demand. At the same time, with longer life expectancy, households tend to save more to prepare for retirement. As a result, the demand for borrowing declines while the supply of funds through savings increases, leaving the market with a relative surplus of funds. This excess supply of capital lowers the price of money—the interest rate.
(2) Conflict between policy objectives: price stability vs. financial stability
Now let’s move on to a more complex issue. Low fertility and population aging do not merely depress the equilibrium interest rate—they also create structural constraints that make it harder to determine the direction of monetary policy itself. In other words, they reduce the room for monetary policy to maneuver in a different way from what we discussed earlier.
As the population ages, the number of retirees increases, economic growth slows, and interest rates trend downward structurally. In this environment, the spread between deposit and lending rates (net interest margin) narrows, and loan demand declines, weakening the overall profitability of financial institutions. If some institutions then turn to riskier assets in search of returns, this could put greater strain on the stability of the financial system as a whole (Jang, 2025).
Particularly, Borrowing is largely driven by real estate purchases in Korea, and household debt has already reached exceptionally high levels. In such circumstances, lowering interest rates to stimulate the economy could accelerate the growth of household debt, thereby threatening financial stability. If the resilience of the financial system has already been weakened by population aging, these side effects are likely to become even more pronounced.
In recent years, there have been periods when housing prices and household debt surged simultaneously. At the time, judging by inflation and economic trends alone, lowering interest rates might have seemed appropriate. However, the already excessive buildup of household debt made it difficult to cut rates, as even a small shock could have triggered financial instability in such a fragile environment.
This policy dilemma is likely to become even more pronounced as population aging accelerates. This is because aging is a structural factor that weakens the fundamentals of financial stability. fundamentals of financial stability. Ultimately, when the goal of stabilizing the economy and prices conflict with that of safeguarding financial stability, the Bank of Korea’s room to maneuver in monetary policy inevitably narrows.
(3) The burden of raising interest rates
What about the opposite case—when the economy overheats or inflation rises and interest rates need to be increased? Even in such circumstances, low fertility and population aging can become factors that constrain monetary policy.
The reason is that as population aging deepens, government spending continues to rise. A prime example is “rigid expenditures” such as pensions and health insurance, which are difficult to reduce. As these expenditures grow, the fiscal burden on the government increases and national debt balloons. According to the National Assembly Budget Office (2025), if the fertility rate remains at around 0.75, the ratio of national debt to GDP—currently about 50%—could soar to 173% in roughly 50 years.
In such a situation, raising interest rates would cause the government’s interest payment burden to surge, increasing the risk that rising fiscal burdens and debt levels feed into a vicious cycle. This creates an environment where it becomes much harder to steer monetary policy in the desired direction. Such constraints are already becoming a reality in “high-debt” countries, including the United States.
Conclusion: Structural reform as both a prerequisite for sustainable growth and a way to give monetary policy room to breathe
In short, structural reform is about building the economy’s muscle—and that muscle is what allows interest rates to work as an effective policy tool.
The structural challenges Korea now faces are weakening the economy’s fundamentals and narrowing the space for monetary policy to operate effectively.
That is why structural reform is urgently needed. If the birth rate recovers, older workers can remain in the labor force longer, more women and young people participate in economic activity, and productivity rises through technological innovation and more efficient resource allocation, our economy can regain its fundamental strength. On that foundation, the central bank’s interest rate policy can once again function with flexibility and effectiveness.
This blog post is based on Chapter 3 In-depth Study: Changes in Monetary Policy Conditions in a Super-Aged Society and Their Implications (June 2025), and on BOK Economic Research No. 2025-12, Demographic Shifts and the Real Interest Rate in an Open Economy: The Case of Korea.
- [1] “The consequences for human welfare involved in questions like these [regarding long-run economic growth] are simply staggering: Once one starts to think about them, it is hard to think about anything else.” in Journal of Monetary Economics, 1988.