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To raise or not to raise

Mar 18,2017
The U.S. Federal Reserve’s interest rate increase on Wednesday puts the Korean economy in a deep conundrum. The country is bombarded with negative factors politically and economically on both domestic and external fronts. Koreans for the first time have to elect a new president within 60 days to replace an impeached president. All the while, a dysfunctional interim government must address a protectionist tide coming from global powers. The economy is sinking fast as growth is stagnant. The current acting government must at least transfer a stable economy to the next leader, who will have to go straight to work without a transition period.

The first rate increase under Donald Trump poses a challenge to the Korean economy. The U.S. rate is at a range of 0.75 percent to 1 percent, putting pressure on the Korean rate which has been pegged at 1.25 percent for the past eight months. If the Fed carries out two more 0.25 percentage point increases this year as indicated, the U.S. base rate will hover above the Korean rate for the first time in a decade. There were two periods in 2000 and 2006 when U.S. interest rates were higher than Korea’s, and the economy suffered a lot from foreign capital flight. One small comfort is that the Fed has sent a consistent message to the market that the increases will be incremental and adjusted according to economic developments.

The problem is that local policy makers do not have many options at hand. The Bank of Korea will have to follow suit and raise rates in order to lessen capital flight and foreign currency and inflation risks. Given domestic conditions like weak growth, sluggish demand and high unemployment, it should lower interest rates to stimulate the economy. Household debt, now approaching 1,300 trillion won ($1.14 trillion), is a ticking bomb. Higher interest rates can deal a fatal blow to Korea’s two million heavily indebted households and wreck the country’s financial system.

The Bank of Korea reiterated that it won’t “mechanically” raise interest rates to follow U.S. policy. It suggested that it will maintain a loose monetary policy by keeping the rate at its current record-low level. But it cannot stay valiant if the Fed keeps raising its rates. Bank Gov. Lee Ju-yeol must strengthen advance guidance as he has promised by maintaining communication with the market and sending clear messages on monetary policy direction.

Interest rates are positioned to go up than down. Local monetary authorities must alarm the market in advance. Good timing is important in monetary actions. If the economy shows dangerous signs, authorities should take radical fiscal actions rather than monetary ones to bolster the economy.

JoongAng Ilbo, March 17, Page 30