[Q&A] Lee Ju-yeol "Interest Rate Normalization Aligned with Economic Improvement... Potential Growth Rate Falls to 2%"

Potential Growth Rate Falls to 2% Range This Year and Next
"Current Situation Cannot Be Seen as a Debt Trap"

[Asia Economy Reporters Eunbyeol Kim and Sehee Jang] On the 26th, Lee Ju-yeol, Governor of the Bank of Korea, stated, "Going forward, we plan to gradually adjust the degree of monetary policy easing in line with the extent of economic improvement."

Governor Lee Ju-yeol of the Bank of Korea made this remark on the 28th, saying, "The first step was taken due to the necessity of alleviating accumulated financial imbalances." This is interpreted as indicating the possibility of additional interest rate hikes within the year.

On the same day, the Bank of Korea's Monetary Policy Committee, chaired by Governor Lee Ju-yeol, held a monetary policy direction decision meeting at the Bank of Korea headquarters in Seoul and raised the base interest rate from the previous 0.50% to 0.75%. This is the first interest rate hike in 2 years and 9 months since November 2018, and the first increase in 15 months since the rate was held steady at 0.50%.

The following is a Q&A session with Governor Lee Ju-yeol.

- To what extent do you expect the risk of financial imbalance to be alleviated by this interest rate hike?

▲ This single measure will not resolve financial imbalances. The current financial imbalances have been influenced by factors other than low interest rates. It will take a long time to resolve the financial imbalances that have accumulated over a long period. Other policies must follow as well. It is true that macroprudential regulations by supervisory authorities have been strengthened regarding household loan growth and housing price increases. Despite significantly lowering the loan-to-value ratio on mortgage loans, profit-seeking behavior through borrowing continues. Even if regulations are strengthened beyond the current level, if expectations that low interest rates will persist for a considerable period remain, the effectiveness of macroprudential policies will inevitably be limited. It is time for monetary policy responses to accompany macroprudential policies.

- There are forecasts that even a 0.25 percentage point increase in the base interest rate will not curb the rise in loans.

▲ Raising interest rates increases borrowing costs for economic agents, which can somewhat reduce risk-taking tendencies. We expect it to have an effect in slowing the increase in household loans and housing prices. However, housing prices are the result of multiple complex factors. Government housing policies and, most importantly, housing supply and demand conditions play a role. While monetary policy approaches are necessary for housing price stabilization, various government policies must be effectively implemented together. This interest rate hike decision was made considering the economic recovery, rising inflationary pressures, and accumulated financial imbalances comprehensively. Going forward, interest rates should be gradually adjusted in line with economic improvement.

- Do you agree with the criticism that we are trapped in a debt trap?

▲ A debt trap refers to a situation where interest burdens become excessive or consumption and investment contract when interest rates rise. Although there have been fluctuations in consumption recently due to COVID-19, we have assessed that economic agents fundamentally have sufficient capacity to increase consumption. Considering household savings rates and robust investment activities, it is difficult to say we are trapped in a debt trap.

- What is the reason for continued real estate price increases despite government warnings of a peak?

▲ Housing prices in the Seoul metropolitan area have risen sharply in a short period. When evaluating housing levels using various standards such as past housing prices and comparisons with other countries, I have previously mentioned that the recent rapid surge in a short period appears to be significantly overvalued. Housing price increases are determined by various factors. Prolonged accommodative monetary policy, government real estate policies, and supply-demand factors have influenced this. Since different factors interact complexly, it is difficult to judge how much adjustment is needed to consider it normalized.

- Do you expect the base interest rate hike to affect loans from commercial banks as well?

▲ Recently, some banks have been taking various measures to manage the increase in household loans. Following the base interest rate hike, household loan interest rates will also rise with a time lag. This will restrict demand for asset investment through borrowing. We expect it to help alleviate excessive private credit growth to some extent. Although interest rate hikes do not determine everything, I believe they will have an effect in curbing borrowing demand.

- There are concerns that the interest rate hike will suppress consumption and investment, leading to a decline in growth rates.

▲ It is natural that raising interest rates will have the effect of suppressing consumption and investment. However, the current interest rate level remains accommodative in various respects. The real interest rate is still in negative territory. It does not seem likely to have a negative impact sufficient to change the fundamental trend of the real economy.

- How should structural reforms to prevent potential growth rate decline be approached?

▲ We estimate that the potential growth rate of our economy this year and next year has declined to around 2%. Two to three years ago, we projected the potential growth rate for this year and next year at 2.5%, but upon re-estimation, it has fallen to 2.2%. The main factors for the decline are the COVID-19 shock, deterioration in the labor market, reduced productivity in the service sector, and demographic structure. To recover previous trends, it is urgent to minimize the lingering effects of COVID-19 quickly. Supporting new growth industries and improving corporate investment conditions are most important. Without dramatically improving the corporate investment environment, it will be difficult to raise the potential growth rate. Persistent efforts are also needed to increase economic participation by women and youth.

- Do you still consider the 0.75% base interest rate accommodative?

▲ Considering the economy and inflation, the current monetary policy is still accommodative. The real base interest rate shows a significant negative value. Taking various factors into account, it is not at a level that restricts the real economy. It is still below the neutral interest rate level.

- How should the term 'gradual' adjustment in the monetary policy statement be interpreted?

▲ It means we will not rush but also must not delay. Variables for additional rate hikes include the future course of the COVID-19 situation. After changes in the COVID-19 situation, we need to observe its impact on the economy and whether the expected growth path proceeds as planned. Also, policy changes by the U.S. Federal Reserve (Fed) will have considerable influence. The development of financial imbalance situations will also be considered.

This content was produced with the assistance of AI translation services.