A last-minute decision

The Bank of Korea on Thursday lowered its benchmark interest rate from 1.5 percent to 1.25 percent. The central bank’s decision to shave off 0.25 percent has pushed Korea into an era of de facto zero percent interest rates when taking into account deflationary pressure on prices. After the unexpected move, Bank of Korea Gov. Lee Ju-yeol said he wanted to give a signal to the market in advance, but circumstances did not allow it.

The bank’s action was propelled by three factors. The first is timing. As the United States is expected to delay its Federal funds rate hike until after September, the Bank of Korea can adjust to that more easily by delaying its own rate hike.

Second, the decision is related to our parlous economic situation. As the government’s fiscal stimuli are concentrated on the first half of the year, concerns are high that the economy could face a fiscal cliff in the second half. If the government-led restructuring of insolvent companies — particularly in the shipbuilding and shipping industries — accelerates, it could lay a heavy burden on an economy already running out of steam. The central bank’s rate cut can compensate for the lack of financial resources on the government’s part.

Third, as the Monetary Policy Committee of the central bank is mostly occupied by dovish members, that helped the bank back up the government’s desire for stimulation with monetary prescriptions.

Changing benchmark rates is a double-edged sword: It can revitalize consumption and investment, but at the same time can cause unwanted side-effects like capital outflows. Moreover, given the rapid aging of our population and ultra-low money rates, the bank’s further rate cut may exacerbate our huge household debt situation.

The Bank of Korea is confident that the current level of household debt is manageable. But despite repeated vows to control the debt, it has nevertheless reached a whopping 1,200 trillion won ($1.04 trillion), doubling over the past 10 years. The government also needs to adjust exchange rates delicately given Uncle Sam’s increasing nervousness, as manifested by U.S. Treasury Secretary Jacob Lew’s recent visit to the Bank of Korea.

Overall, local markets seems to show a positive response to the cut. If benefits are bigger than side effects, the government can resort to extreme remedies. Fortunately, the central bank is in sync with the government on the economic front. The administration, companies and households must be determined to rejuvenate our lethargic economy.

JoongAng Ilbo, Jun. 10, Page 30