[Opinion] How Should We View the Policy Authorities' Response to Household Debt?

Professor Kim Hong-beom, Department of Economics, Gyeongsang National University

Household debt has risen sharply over the past two years. Recently, the central bank (Bank of Korea)'s decision to raise interest rates and the financial authorities' (Financial Services Commission and Financial Supervisory Service) declaration of policy intentions have attracted attention. At the end of August, the Bank of Korea slightly raised the base interest rate for the first time in 15 months. In early September, the financial authorities declared a 'strengthening of household debt management.' The Bank of Korea and the financial authorities publicly pledged to "closely cooperate to manage financial imbalances such as household debt." How should we view these moves by the two policy authorities?

Managing household debt is closer to symptomatic treatment rather than addressing the root cause (stabilizing the real estate market). This is because the current household debt mainly stems from the sharp rise in housing prices and rent prices caused by the anticipated failure of anti-market real estate policies. However, it is widely known that a complete overhaul of real estate policy cannot be expected from the current government. The only remaining option is to manage household debt.

Household debt, which entered an upward phase from the third quarter of 2019, is still ongoing (based on the year-on-year growth rate of household credit). The Bank of Korea and financial authorities should have communicated with the market earlier before the problem grew this large. Even considering the time lag, they should have led the market with a firm policy intention not to overlook systemic risks from household debt by mid-2020.

Our economy also experienced a rapid increase in household debt in the mid-2010s. In August 2014, the previous government's 'new economic team' eased loan-to-value (LTV) and debt-to-income (DTI) regulations to stimulate the real estate market. The Bank of Korea also cut the base interest rate four times consecutively over 10 months starting in August of the same year (a total cut of 1 percentage point). Riding the steep upward trend, household debt increased by 286 trillion KRW over 27 months (September 2014 to December 2016).

Interestingly, the current situation resembles that period. In mid-2019, market instability was accumulating due to the government's successive real estate regulations. Starting in July of that year, the Bank of Korea cut the base interest rate four times consecutively over 10 months (a total cut of 1.25 percentage points). Household debt, which soon entered an upward phase, increased by 249 trillion KRW over 24 months (June 2019 to June 2021). The financial authorities, who were focused on restructuring household debt, remained silent for 17 months (June 2019 to October 2020).

Of course, the two authorities do not make policy decisions based solely on household debt. Considering the COVID-19 crisis that emerged in early last year, a simple comparison between the mid-2010s and the recent two years may be unreasonable. Still, questions remain. When the Bank of Korea cut the base interest rate twice consecutively in the second half of 2019, what prior preparations did it make for the potential accumulation of financial imbalances caused by this? Wasn't the Bank of Korea already well aware of the dynamic relationship between the base interest rate and household debt? Why did the Bank of Korea and financial authorities not immediately manage the clearly accelerating household debt trend that became evident by mid-2020? In short, it is hard to say that the recent moves by these policy authorities are anything but a belated response.

What are the improvements? First, a macroprudential policy system specialized in financial stability must be established. The 'Macro-Financial Meeting,' known as an informal body dealing with macroprudential issues, has never timely addressed household debt problems, neither seven years ago nor this time. Second, the Bank of Korea must elevate its legal independence to actual independence. Its own efforts to maintain an appropriate distance from the political sphere are crucial. Meanwhile, the financial authorities' problem should be resolved through the supervisory reform that has been postponed for 20 years.

Kim Hong-beom, Professor of Economics, Gyeongsang National University