[Insight & Opinion] Interest Rate Cuts Are Highly Likely to Become a Disaster

Household Debt and Real Estate Prices Have Hit Their Limits
Lowering Rates Now Could Add Fuel to the Fire
Recalling Policies That Encouraged Borrowing to Buy Homes

The United States has lowered interest rates. Many people are hoping that South Korea will follow suit and cut its base interest rate. I often compare the central bank's monetary policy to opening and closing the floodgates of a dam, and the government's fiscal policy to creating waterways from the dam's released water to parched rice fields. Although interest rates have been cut, the fact that money is not translating into production or domestic consumption is akin to opening the dam's floodgates but much of the water leaking away to unintended places. It is well known that Japan and several European countries have kept their dam floodgates wide open for a long time, yet the water did not properly reach the fields.

South Korea's economy is in a precarious state. Above all, the situation for small business owners is not improving. According to Statistics Korea, the number of middle-class households running deficits continues to rise. Real income is decreasing. The worsening wealth inequality among citizens, due to rising housing prices and other factors, is also a problem. With the economy in such poor shape, calls to lower the base interest rate to stimulate the economy are growing louder. Ahead of the October Monetary Policy Committee meeting, the Deputy Prime Minister for Economy and the Governor of the Bank of Korea are scheduled to meet for lunch on September 30. The financial market expects the Deputy Prime Minister to request an interest rate cut from the Bank of Korea Governor to aid economic recovery.

This brings back difficult memories from 10 years ago. Searching economic news from 2014 reveals many articles titled "The Bank of Korea Governor Responds to Choi-nomics." These articles suggest that the Bank of Korea cut the base interest rate at the government's request to stimulate the economy. At that time, as someone working in the bond market, I vividly remember being deeply disappointed with the Bank of Korea for implementing an excessive rate cut. It was clear that such an excessive rate cut would not only fail to stimulate the economy but would also lead to a long-term decrease in demand due to increased household debt and a decline in real income caused by rising real estate prices.

Since the 2010s, the government has significantly reduced real estate-related taxes such as comprehensive real estate holding tax and capital gains tax, while expanding taxes related to the financial market, including abolishing the dividend income tax exemption for long-term stock investors and strengthening the comprehensive taxation of financial income. All waterways were directed toward the real estate market. When the Bank of Korea opened the dam's floodgates wide in 2014, naturally, the water did not flow to the fields but leaked into the real estate market. The subsequent surge in household loans, soaring real estate prices, reduced consumption, and increased living costs have continued to cause suffering for the people.

The difference now compared to 10 years ago is that the issues of household debt and real estate prices have already reached their limits. For this reason, the Bank of Korea has raised interest rates and closed the floodgates several years ago. However, the government's easing of real estate taxes such as the comprehensive real estate holding tax and the introduction of various real estate loan programs to prevent a reduction in household loans remind one of the policy from 10 years ago encouraging borrowing to buy homes. If the base interest rate is lowered under these circumstances, it would be like pouring oil on the fire, exacerbating the problems.

Generally, in a sound capitalist economy, recessions and booms alternate, and the economy develops. However, when excessive household debt exists, recessions are more likely to escalate into crises or become prolonged. The situation feared 10 years ago has become the reality today. I sincerely hope that the current concerns do not materialize in the future. This is why I strongly oppose lowering the base interest rate.

Seo Junsik, Professor of Economics, Soongsil University