[EDITORIALS]A rate increase is in orderThe gap between market-based interest rates and the central bank’s call rate is growing wider, while the Bank of Korea takes no action on its monetary policy. The central bank has pegged the call rate at 3.25 percent for seven months now. However, the rate on the benchmark government bond, which is often quoted as a representative interest rate, has gradually risen closer to 4 percent.
This means that the market sees rates increasing in the future. The central bank is now exerting all its effort to keep market rates down by buying treasury bonds, but this only allows sellers a chance to unload their holdings.
Amidst all this, the side effects of low interest rates are growing. The money floating around in the market, which is estimated at 470 trillion won ($470 billion), together with low interest rates, work to put upward pressure on real estate prices. Even if people save money little by little, the interest they can earn on their savings is only around 3 percent per year. People who live on interest income have to tighten their belts further.
Although rates are low, there is no indication that the money will flow to productive sectors, such as loans to businesses. Therefore, financial companies are only eager to increase mortage loans for buying housing units. If this continues, the financial sector won’t be able to operate normally.
It has been the case for quite some time that the low interest rate policy hasn’t worked as an incentive for economic recovery. The functioning of interest rate policy to control the economic cycle has failed.
In addition, many countries continue to increase interest rates gradually. If the U.S. Federal Reserve raises its key federal funds rate by a quarter of a percentage point, the rate will be the same as the Bank of Korea’s rate. If this happens, it is quite likely that we will have to worry about a large-scale outflow of capital to overseas markets. It is burdensome for Korea to peg its interest rate at the present level continuously.
If we can’t boost the economy with low interest rates, we must consider raising them so that we can clear the side effects of low rates and normalize the flow of money. We probably cannot stop cash from flowing into the real estate market with a slight interest rate increase, but it is necessary to send a signal to the market that interest rates can be raised.
If the central bank misses the chance to raise its rate this time, the burden from low rates will grow bigger.