Bracing for the rate hike

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Bracing for the rate hike

In the last few weeks, financial markets around the world fluctuated over the prospect of an interest rate hike by the U.S. Federal Reserve. Korea’s stock market and exchange rate moved drastically as well. The market was shaken as remarks by the hawks and doves of the Federal Open Market Committee (FOMC) were made public.

The hawks argue that the interest rate should be raised now, considering the growth rate of the U.S. economy. If the interest rate increase is delayed, it could lead to bubbles in asset prices and another crisis. They say that if the interest rate is increased gradually and predictably, its impact on the global economy won’t be serious.

However, the doves claim that the growth of the U.S. economy is not solid yet and the ultra-low interest rate should be maintained for now. A hasty increase is likely to hinder economic recovery. The rate of the price rise is low, and the risk of bubbles in asset price is small. Also, they warn of the possibility of chaos in the global economy as a result of a U.S. interest rate increase.

The Fed had been maintaining a “zero interest rate” since the 2008 global financial crisis and raised it to 0.25 percent in December 2015. Unlike the predictions for another increase, it hasn’t changed the rate, due to the unexpected external factor of Brexit and uncertainty in the recovery of the U.S. economy.

At the Fed annual conference held in Jackson Hole, Wyoming on August 26, Chair Janet Yellen said, “In light of the continued solid performance of the labor market and our outlook for economic activity and inflation, I believe the case for an increase in the federal funds rate has strengthened in recent months.” It was a rather hardline remark from the dovish chairperson. So there were many predictions that the Fed would increase the rate by 0.25 percent within the second half of the year, as early as September.

The FOMC is to meet three more times this year, this week, November and December. The November 2 meeting is right before the presidential election, and making the interest rate increase may be politically uncomfortable. If an interest rate increase is needed this year and December is too late, the Fed is likely to make the rate increase at this week’s meeting, some predict.

However, as the employment and consumer spending indicators in September did not meet the expectation of the Fed, the voices of the doves are gaining traction. The market prediction for the FOMC increasing rates this week is a likelihood of less than 20 percent.

Some critics say that the Fed encourages market uncertainty with an ambiguous standpoint. The grounds for an interest rate increase are not clear, and the actions are unpredictable. The Fed policy deviates from the expected course of monetary policy calculated based on major economic variables. Some even insist on changing the way monetary policy is operated.

Proposed alternatives include a plan to set a goal of a certain nominal national income growth rate, the sum of economic growth rate and price increase rate, and a plan to raise the target price increase rate in order to more actively respond to the crisis.

Many experts think that the Fed will increase the rate in December, and U.S. monetary policy would be back on track. Keeping up with the U.S. economy’s recovery, the Fed is expected to gradually increase the rate at the end of the year.

The interest rate of the United States has a considerable impact on Korea’s monetary policy and financial market. Korea needs to prepare for a sudden departure of funds and instability in the foreign exchange and financial market in case international liquidity is reduced as a result of a U.S. interest rate increase. Also, the Korean economy is affected by not just the U.S. but also China and Japan’s economic situations and monetary policies, and we need a thorough analysis and prediction for the overall global economy.

Today, Korea’s economy is very unstable due to the poor performances of export industries, delayed corporate restructuring, an inefficient financial sector and an overheated real estate market. We need to constantly improve the vulnerable parts and coordinate fiscal, monetary, financial supervisory, foreign exchange and macroeconomic policies to respond to a U.S. interest rate increase and global economic changes.

We also need to strengthen international financial cooperation and policy coordination, including the currency swap with Japan.

It is hard for emerging economies like Korea, which is completely open to the flow of foreign capital, to independently set interest rates. As the actual economy is sluggish and the rate of price increase is low, the Bank of Korea may be faced with the challenge of increasing the domestic rate to keep up with the international rate increase. It is easy to lower the interest rate, but raising it is politically very difficult. Considering the impact of international and domestic interest rate increases on the Korean economy, authorities need to prepare ideal monetary policies and strategies for various scenarios.

The scorching, hot summer is gone, and soon, a cold spell will arrive. The cold air from the other side of the Pacific will affect the economy as well. If we are not prepared for cold, it could become pneumonia. We need to be prepared for climate change in the global economy.

Translation by the Korea JoongAng Daily staff.

JoongAng Ilbo, Sept. 19, Page 31

*The author, a former senior economist at Asia Development Bank, is a professor of economics at Korea University.

Lee Jong-wha
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