A meaningless move
This is unprecedented in Korea. After taking office, Choi Kyung-hwan, the deputy prime minister for the economy, said the country may have to take an uncharted path to revive the economy. But little did ordinary consumers imagine that the path would lead to near-zero interest rates. Gone are the days when interest on bank savings was a significant part of household income. Those who dare not take risks with their money or open their own business after retirement cannot but worry as they helplessly watch interest rates erode.
There is no meaning to the central bank’s rate cut apart from the fact that it is in line with the government’s stimulus campaign. It likely will be of little use in reviving domestic demand. Consumers no longer borrow or withdraw money from savings to spend just because interest rates go down.
A turning point in consumer spending occurred between 1999 and 2002. Annual growth in disposable household income during those four years averaged 5.6 percent, a third of the 15-year average of 15.7 percent before the 1997 financial crisis. Yet gains in spending remained robust at 12.9 percent a year, down just slightly from the pre-crisis level of 14.9 percent. The gap was financed by a sharp drop in consumer savings and more household debt. The net household savings rate plunged to 0.4 percent in 2002 from 21.6 percent in 1998. Debt amounted to 114 percent of disposable household income in 2002. Consumer spending has never really recovered since then. Savings hardly grew over the past decade, while household debt surged to dangerous levels and continues to pile up.
Consumer spending became constrained by disposable income following the four-year debt-financing spending spree. Real consumption rose 5.3 percent on average from 2003-12, more or less in line with the 5.7 percent growth in disposable household income. From 2008, the two pieces of data moved in sync as represented by the 0.95 percent correlation coefficient in the pace of growth. This suggests that consumption entirely hinged on monthly earnings. It explains why consumer spending has remained stubbornly depressed regardless of several monetary easing measures since 2003. To revive domestic demand, corporate cash hoards must trickle down to benefit households, as the deputy prime minister for the economy has pointed out. Reviving that benign cycle is the fundamental solution rather than pursuing interest rate cuts.
Bank of Korea Governor Lee Ju-yeol has championed the “normalization” of interest rates, which means the Korean central bank may have to follow suit if its U.S. counterpart begins tightening next year. Rate hikes won’t be easy when households are battered with excessive debt. The challenge has become greater now that the central bank has brought down the rate. Some argue for further easing, even suggesting that rates be lowered to near zero, which has become common in advanced economies. But the zero interest rate zone is limited to the markets of the U.S. dollar, the euro and the Japanese yen - all international reserve currencies.
The Korean won is hardly a global currency. If rates are pushed to zero, the won indeed would go astray in an uncharted path.
Translation by the Korea JoongAng Daily staff.
*The author is a senior research fellow at the Korea Institute of Finance.
BY Park Jong-kyu