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In the interest of the economy

Aug 24,2018
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Yi Jung-jae
The author is a columnist of the JoongAng Ilbo.

No president likes a hawkish central bank head, especially if the leader wants to show off economic accomplishments. When interest rates are low, it is easier to lend money and both investment and consumption rise. U.S. President Donald Trump criticized Federal Reserve Chairman Jerome Powell a few days ago. He said he was “not thrilled” by interest rate hikes. The Fed chairman wouldn’t want to go against the president who appointed him, but if he does not raise interest rates, the economy could overheat. The shocks would have to be borne by the citizens. In fact, the duty of the central bank chief is fighting inflation.

Another job of the Bank of Korea (BOK) governor is preventing foreign capital from fleeing the country. As Korea is a mid-sized open economy, money flows out easily. This is especially so when interest rates in the United States are higher than Korea’s, or when emerging economies go through a crisis. This year, U.S. interest rates are around 0.5 percent higher than Korea’s, and Turkey is going through a crisis. The U.S.-China trade war is intensifying. But this year, the Bank of Korea hasn’t raised the base interest rate due to the weakness of the economy. If the economy and employment were not so sluggish, the central bank would have raised the benchmark rate already. Or it would at least be raised at the Monetary Policy Committee scheduled next week. But the employment shock from the drastic minimum wage hike has erased that possibility. The market predicts that the interest rate is not likely to be raised in August, or within the year.

A high-level Blue House official on Tuesday went so far as to say that Korea needs to have policies that suit Korea’s situation, even if the United States raised its interest rates. The local economy is so feeble that the Bank of Korea cannot raise interest rates, and yet the government is pressing the central bank to care for the economy. That day, the interest rate for Korea’s national bonds all fell. The rate for a three-year bond was 1.919 percent, the lowest for the year. The market sees that the central bank is not likely to raise the interest rate against the will of the Blue House. Nevertheless, I urge BOK Gov. Lee Ju-yeol to make a decision. The benchmark interest rate needs to be raised within the month. October is too late. Here’s why.

First, economic entities should be given time to prepare. The damage will be even greater if a hike comes later. The United States already signaled a hike for September. Then, the difference between interest rates in the United States and Korea could grow to 0.75 percent. A bank head said a 0.75 percent difference cannot last long and that if foreign capital starts to flee the peninsula, it could lead to a sudden interest rate hike. The Federal Reserve is likely to increase the federal funds rate once again in November. When the difference between the rates in Korea and the U.S. was inverted to 1 percent between May and July 2006, about 2.7 trillion won ($2.4 billion) on average in foreign capital fled. At the time, the benchmark rate in the United States was at the 5 percent level, but it is 2 percent now. The shock to the market may be greater now than it was then.

Second, a hike in the interest rate can calm groundless optimism in Korea. When the Bank of Korea raises the interest rate, the economy could turn to retrenchment. The Ministry of Finance can no longer say the economy is improving, and President Moon Jae-in’s policy chief Jang Ha-sung will have trouble asking the public to wait a little bit longer for things to get better by the end of the year.

Third, the Bank of Korea must communicate with the market. Last month, the Monetary Policy Committee had a minority opinion on an interest rate hike. The BOK has customarily raised the rate within a month or two after a minority opinion. Only when the bank follows in such footsteps can it send the message that it is only focusing on the market and economy, not on the politics of the situation. It should forget politics and any comments from the Blue House.

If the interest rate is not raised, the Korean economy’s health may be suspected externally. Some may think that the economy is too weak to raise the interest rate after the minimum wage increase. It will be a hard choice for Gov. Lee Ju-yeol. It’s not easy to be a central bank head.

JoongAng Ilbo, Aug. 23, Page 30