firmly in place has been confirmed through an abundance of historical evidence.
Raise Interest Rates Before Too Late
Call rate fell below 10% in 1998 and it has been frozen to 3.25% for half a year until now. Policy makers weigh the pros and cons of a policy before adopting it. The government expected low interest rates would promote investment, activate the stock market, reduce household debt, and thus increase consumer spending. 6 years have elapsed and the plan failed to meet the expectation. In contrast, the ill effects of low interest rates are evident. It's been a long time since the sharp increase in household debt and personal bankruptcy began to threaten Korea's economy. Low interest rates make the restructuring of the insufficiently competitive firms impossible. In addition, the policy, almost dropped in the liquidity trap, leaves no room for the government to employ financial policies. Above all, investors who have bitter experiences about the stock market are reluctant to invest their money in it, making money of over ￦400 trillion floating. This can lead to the collapse of Korean economy anytime.
Therefore, not only the academic world and the press but an official of Korea Bank has not seldom recommended that the government raise interest rates. In this regard, it's already late to raise interest rates. It is said that Monetary Policy Committee had a heated discussion about a policy of low interest rates, on June 9, 2005 at the regular meeting. Some of them worried about the impact of raising interest rates on our economy. Now the policy seems to put Korea Bank in a dilemma. The primary reason they are reluctant to raise interest rates is Japan's experience of the lost 10 years, due to the collapse of asset value provoked by the raising of interest rates. Given that the target of the current policy is not solely set for the booming of stock market, the following differences between Korea's economic situation of now and Japan's at that time will help the government to raise interest rates.
First, Koreans still remember the time they could draw a high income from interests, for the rates have sharply lowered. In Japan, interest rates have remained below 10% since the 1950's and 5% since the early 1990's. By contrast, those in Korea have remained below 20% since the 1970's, 15% the 1980's, 10% the 1990's, and reached 4% now. That is, we have experienced one digit of interest rates only for 5-6 years but Japan for more than 50 years. High interest receipts were the greatest motivation for hard working and saving but 4% of interest rates became a shock to household economy. Granted, those who fear the stock market and can't be content with the current interest rates are tempted to invest in real estate whenever they get a chance. Due to inconsistent governmental policies among industries, regions, and macro/micro economy as well as their failure, real estate market came to have more appeal for investors. This means not only that Korea's real estate bubble could be bigger than Japan's but the bubble would be more difficult to burst.
Second, while the real estate bubble in Japan occurred with a sudden rise in the stock market, that in Korea did with the depressed stock market. This indicates there's no stock market bubble in Korea at least. Moreover, Japan's real estate prices rose more than four times as much as they used to between 1984 and 1990 but Korea's less than two times between Dec. 1998 and the end of 2003. The prices seemed to be stabilized when 10.29(October 29th) policy was introduced but began to rise again after the government enforced a new policy to curb the supply of medium- and large-size apartment houses as well as the demand. The government failed to understand that people prefer a larger and more luxurious house as their income level rises. The government's way of thinking may be in the 1970-80's or it pictures only the life of the lower income bracket to itself.
It is significant that a hike in the price of real estate is not a nationwide phenomenon in Korea. Given that floating money in Korea may amount above ￦400 trillion, if the government fails to bring changes to its policy, the bubble in real estate market can begin nationwide. Japan decided to raise interest rates after once the bubble had formed and the break of the bubble was the beginning of the recession. Korea Bank, therefore, must acknowledge it is the last chance to raise interest rates when the bubble has just begun to form. Increased interest rates can enable floating money to be absorbed into the financial sector, prevent overheated stock market, and motivate the financial institutions to operate real estate loan system conservatively by drawing the attention of lenders and financial sector to the seriousness of household debt. Apart from this, the government can expect consumer spending will increase as interest income rises, promoting investment. With regard to the transmission mechanism of interest rates policy, the government may be able to employ an idea opposite to the logic of macroeconomics.
Even if the real estate bubble has already begun, the impact can't be greater than that of Japan, for Korea's economy heavily depends on overseas countries. In addition, Korea's collateral settlement requirement rate is only half Japan's (120%). Because the bubble tends to break when financial institutions require additional collateral as real estate prices fall, the impact of bubble burst in Korea would not greater than that in Japan.
Hence, it's time to raise interest rates, for the bubble has just begun, and if any, the impact of bubble burst would not be as great as Japan's. The authorities of Korea Bank must make a right decision.
Bae Jinyeong (a professor of Inje University, Division of Economics and Commerce, email@example.com)