[Insight & Opinion] Strategies Needed for a Soft Landing of the Economy

Slow Down Rate Hikes
Ease Real Estate Regulations and Taxation

Kim Jeongsik, Professor Emeritus, Department of Economics, Yonsei University

[Asia Economy] With expectations that US inflation has peaked, the US Federal Reserve (Fed) raised interest rates by 0.5 percentage points in December, increasing the likelihood that the final rate next year will stabilize around 5%. However, even if the US stops raising rates, high inflation will keep interest rates in the 5% range for some time, deepening the economic recession not only in the US but globally. A global economic recession could cause a hard landing for our export-dependent economy, worsen corporate and household debt defaults, and trigger a financial crisis by bursting the real estate bubble. Urgent measures from policymakers are needed.

First, the pace of interest rate hikes should be slowed and the magnitude reduced. So far, the Bank of Korea has raised rates sharply to curb inflation and narrow the interest rate gap with the US. The benchmark interest rate has been raised by 2.5 percentage points in a short period, and loan interest rates have reached 7-8%. Due to this heavy interest burden, the capital market has recently tightened, and the risk of household debt defaults is increasing. If exports decline next year due to the global recession, a hard landing of the economy is a concern. In fact, the Korea Development Institute (KDI) recently lowered its growth forecast for next year to 1.8%. Fortunately, the previously rising exchange rate has stabilized recently, so the Bank of Korea should focus on a soft landing by reducing the size and pace of rate hikes. This approach will also prevent the contradictory policies of the Bank raising rates while the government increases market liquidity through the bond stabilization fund.

Next, caution is needed in sharply reducing government spending to maintain fiscal soundness. Fiscal soundness has deteriorated significantly due to increased government spending in the previous administration. This is expected to worsen further with the aging population trend and low-growth phase ahead. The government's plan to secure fiscal soundness early by cutting unnecessary spending is the right direction. However, too rapid a reduction in government spending could cause a hard landing of the economy and reduce government support.

Finally, regulations on real estate should be eased and abnormal tax policies normalized. As low interest rates drove up real estate prices, policymakers designated speculative areas to regulate loans and significantly raised capital gains tax, acquisition tax, and comprehensive real estate holding tax rates. While advanced countries have capital gains taxes around 20%, ours have been raised up to 83%. However, real estate prices are more influenced by interest rates than tax policies, so despite punitive taxation, recent rate hikes have lowered sale and rental prices by 40-50%.

A hard landing in real estate prices causes crises by increasing financial distress through construction company bankruptcies and mortgage loan defaults. The government recognizes this and recently lifted the designation of speculative overheating zones except for Seoul and the metropolitan area. However, this alone is insufficient. It is necessary to expand the lifting of speculative area designations and fully normalize tax policies.

All economic crises stem from a hard landing of the economy. The export-dependent Korean economy is vulnerable to a global recession. To achieve a soft landing for next year's economy, which faces concerns of simultaneous domestic and export downturns, policymakers need to shift the focus from inflation control to economic soft landing and establish interest rate and fiscal policies accordingly.

Kim Jeong-sik, Professor Emeritus, Department of Economics, Yonsei University