Responding to the Fed
The Bank of Korea surprised the markets earlier this month when its monetary policy committee lowered the key interest rate to the historically low level of 1.75 percent. At a regular meeting of the Federal Open Market Committee (FOMC) last week, Chair Janet Yellen set the stage for the key U.S. rate to go higher for the first time since 2006. Experts, market watchers and investors are mixed on what the impact would be from the decoupling of the U.S. and Korean rate policy and how the U.S. rate direction can affect monetary policy here.
In a recent meeting, the Federal Reserve dropped the word “patient” from its guidance on interest rates. Although an increase in rates at an upcoming meeting in April “remains unlikely,” the Fed said it would raise rates once “it has seen further improvement in the labor market and is reasonably confident that inflation will move back to its 2 percent objective over the medium term.” The market is now forecasting the Fed will act in September or October, but does not expect the pace or margin to be steep. U.S. consumer prices fell in January and its manufacturing index slipped in February from the month before. Exports also decreased by about 3 percent. The circumstances are too fragile for the U.S. monetary authority to raise interest rates and risk upsetting the recovery. Its consideration of “international development” also suggests that it won’t be hasty in tightening rates.
When U.S. interest rates go higher, the dollar will strengthen and capital parked in emerging markets may be yanked out, causing jitters in global capital markets. When former head of the Federal Reserve Ben Bernanke first indicated tapering in the bond purchase program in May 2013, currencies and stock markets trembled in the BRIC countries - Brazil, Russia, India and China, which are also referred to as the Fragile Four. When a scaling down was announced at year-end, the angst got bigger. Even in the macroeconomic context, the emerging markets look vulnerable. Their growth substantially slowed since the global financial meltdown of 2008 and their export prices have been on a downward spiral since 2013. In theory, the U.S. rate hike has already been reflected in the market to some extent. If the tightening proceeds faster than expected, the markets could be upset. But the FOMC was unequivocal in its message that the increase would be gradual. Share prices on the U.S. market and elsewhere were lifted by the recent FOMC statement. Currencies of emerging markets also grew stronger.
The Korean market has built considerable resilience against external shocks due to improvement on the foreign currency front. Foreign exchange reserves have reached over $360 billion and short-term foreign-denominated debt has decreased to $115 billion. The current account surplus is expected to top $100 billion this year. South Korea won’t be as shaken by external surprises as during the Asian financial crisis in late 1990s and the Wall Street-triggered financial meltdown in 2008. Korea nonetheless will be affected if troubles in weak emerging economies deepen and exports are slowed.
The best defense against any upset from a U.S. rate hike would be better economic fundamentals through a pickup in the domestic economy. Authorities should try to fend off any ills from worsening of emerging economies and further strengthen foreign exchange-related data. The monetary and fiscal mix of a rate cut and additional spending plan of 10 trillion won ($9.06 billion) comes at the right time. The local monetary authority could consider another rate cut if necessary. The downside from further easing - an increase in the nation’s household debt - could be reined in through discipline in lending.
Some advise synchronized rate action - shifting to higher rates upon a hike by the United States. But we can worry about that later. For now we should keep an expansionary stance to bolster the economy. We can follow suit once our economy improves.
Our monetary trend since the 1990s shows that we acted from nine to 17 months later in response to a rate hike or cut in the United States. During a tightening cycle in the United States in 2004, the Bank of Korea implemented two cuts. The study of correlations also suggests that financial troubles arrive in emerging economies after U.S. rates went substantially higher rather than immediately. It is therefore premature to worry about the impact of a U.S. rate hike.
In today’s international order, it is impossible to have a stable foreign exchange rate, free capital movements, and independent monetary policy all at the same time. Since we have no control over capital movements, we must choose between a monetary policy that works best for our economic conditions and a stable foreign exchange rate. The choice should not be difficult if we look at what our economy needs right now.
Translation by the Korea JoongAng Daily staff.
JoongAng Sunday, Mar. 22, Page 23
*The author is the head of economic research at LG Economic Research Institute.
by Shin Min-young