Knee-jerk reaction

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Knee-jerk reaction

The Bank of Korea raised the nation’s benchmark interest rate by 0.25 percentage points on Tuesday for the second time this year as part of a move to ease inflationary pressures.

The consumer price index shot up to 4.1 percent in October, and observers fear it will head even higher over concerns that asset bubbles are forming in Korea and other countries as the result of quantitative easing measures implemented by the United States to increase the supply of money.

The central bank also took its cue from last week’s G-20 Summit in Seoul, where world leaders agreed that emerging market economies should take “carefully designed macro-prudential” measures to mitigate the risk of “excessive volatility and increasingly overvalued flexible exchange rates.”

The BOK’s response to the current situation, however, was too run-of-the-mill and overdue to have any significant effect.

Its previous move to lift the key interest rate from a record low of 2 percent occurred in July after consumer prices rose on higher-than-expected growth figures for the nation. The central bank then held off boosting the rate further in ensuing months, citing a stagnant real estate market in September and volatile exchange rates in October. It now has put its foot back on the accelerator - after the consumer price index hit a 20-month high.

Good timing is essential in monetary policy. Bond yields, which in theory should move in lock-step with rate hikes, fell sharply despite the monetary decision on Tuesday. The central bank will run out of monetary ammunition if this fails to move the market.

Consumer prices are already on the upswing, and speculative real estate investments have again surfaced in some regions. Rather than react to situations after they play out, the BOK should anticipate the economic landscape and take pre-emptive actions to mitigate risks. At the very least, the central bank should ensure its measures are in line with market expectations to give businesses, investors and others enough time to brace for the changes.

If the situation deteriorates, the government risks having to hike interest rates by a wide margin in a short period of time, which can throw the entire economy off track and upend the stock market.

The Bank of Japan made that mistake in 1990, as did the U.S. Federal Reserve in 2007.

Careful and predictable monetary action is necessary in times like these.
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