The Bank of Korea: "When interest rates rise... clear consumption contraction in households with high debt and no home"

Analysis of Heterogeneous Effects of Interest Rate Hikes on Consumption
High Debt-Non-Homeowner Groups Show the Most Pronounced Consumption Slowdown
Even Homeowners with High Debt Experience Significant Consumption Decline

The Bank of Korea explained that if the interest burden increases due to continued interest rate hikes, low-income households will reduce essential consumption, while middle-class and higher households will cut discretionary consumption, potentially accelerating the slowdown in household consumption. The decrease in consumption was found to be particularly significant among groups with high debt and those who do not own homes.

On the 7th, the Bank of Korea analyzed in its BOK Issue Note report titled "Heterogeneous Effects of Consumption Reduction Due to Interest Rate Increases" that when the Debt Service Ratio (DSR) rises by 1 percentage point, the annual consumption of all households decreases by 0.37%.

As interest rates rise, the increasing interest burden acts as a factor slowing private consumption, but since individual households differ in income and debt levels, the impact of a DSR increase on consumption choices inevitably varies. Accordingly, the Bank of Korea used data from the Korean Labor Panel Study (KLIPS) to subgroup households by income, debt level, and homeownership status, and empirically analyzed the heterogeneous effects of consumption reduction due to interest rate hikes.

The results showed significant differences in the consumption reduction effect from a DSR increase depending on household characteristics. First, low-income households with high debt saw consumption decrease by 0.47% when the DSR rose by 1 percentage point, exceeding the overall household consumption decrease (-0.37%) by a large margin.

Under the same conditions, consumption among middle- and high-income households with high debt also decreased by 0.46%, showing no quantitative difference. However, considering the higher proportion of essential consumption among low-income groups, the qualitative impact of consumption contraction was assessed to be greater in high-debt, low-income households.

When analyzed based solely on income without considering debt, consumption in low-income households was estimated to decrease by 0.28% with a 1 percentage point increase in DSR, while consumption in middle- and high-income households was estimated to decrease by 0.42%.

Regarding this, the Bank of Korea explained, "For low-income groups, the proportion of discretionary consumption beyond essential consumption is small, making further consumption reduction difficult, whereas middle-class and higher households have a higher proportion of discretionary consumption, allowing greater room for consumption adjustment."

Additionally, households with high debt but without homeownership experienced a 0.42% decrease in consumption when the DSR rose by 1 percentage point, showing a relatively greater degree of consumption contraction compared to other households.

Among high-debt homeowners, those with a heavy principal and interest repayment burden experienced a relatively larger consumption reduction effect due to a DSR increase. High-debt homeowners with low DSR levels saw a significant reduction in the consumption decrease effect, which is believed to be because they have greater potential to secure consumption funds by utilizing their owned homes.

The Bank of Korea stated, "If the financial burden on households increases in the future, consumption among typical vulnerable groups with high debt and low income may decrease mainly in essential consumption, while for middle-class and higher households, consumption may decrease mainly in discretionary consumption, so policy design should take this into account."

It added, "In the medium to long term, managing household debt at an appropriate level is expected to contribute not only to financial stability but also to economic stabilization through smoothing consumption."