"When Housing Prices Fall, Consumption Also Drops... Interest Rate Management Must Be Careful"

FKCCI Announces 'Relationship and Implications of Base Interest Rate, Housing Sale Prices, and Private Consumption'

Concerns have been raised that private consumption in the first quarter will slow down due to a decline in housing prices caused by interest rate hikes.

The Federation of Korean Industries (FKI) announced this on the 3rd through an analysis titled "The Relationship and Implications between the Base Interest Rate, Housing Sales Prices, and Private Consumption."

Due to the decrease in household loans following the Bank of Korea's base interest rate hikes, housing sales prices, which had shown strength until now, have been on a downward trend since the second half of last year. The base interest rate hikes began in August 2021, household loan reductions started in January 2022, and housing sales price declines began in August 2022. There is a 12-month lag between the start of the Bank of Korea's base interest rate hikes in August 2021 and the decline in housing sales prices in August 2022.

The FKI pointed out that one reason for the 12-month lag between the base interest rate hikes and the decline in housing sales prices is the high proportion of fixed-rate mortgage loans, meaning that mortgage interest rates do not rise proportionally as the base interest rate increases. In fact, from January 2021 to February 2023, the slope of the trend line for base interest rate hikes was 0.13, whereas the slope for mortgage loan interest rate hikes was only 0.05.

According to an empirical analysis by the FKI based on quarterly data from the second quarter of 2003 to the fourth quarter of 2022, the Bank of Korea's base interest rate statistically significantly affects the rate of change in housing sales prices (real terms, hereafter the same), and the rate of change in housing sales prices statistically significantly affects the growth rate of private consumption.

Photo by Yonhap News

Based on these points, the FKI established and estimated models in which the base interest rate, household loan growth rate, and consumer price inflation rate explain the housing sales price growth rate, and the housing sales price growth rate explains the private consumption growth rate.

The estimation results showed that if the base interest rate one quarter prior is 1 percentage point higher, the housing sales price growth rate in the current quarter decreases by 0.17 percentage points, and if the household loan growth rate one quarter prior rises by 1 percentage point, the housing sales price growth rate in the current quarter increases by 0.56 percentage points. When the consumer price inflation rate one quarter prior rises by 1 percentage point, the housing sales price growth rate in the current quarter increases by 0.57 percentage points.

Meanwhile, it was estimated that if the housing sales price growth rate falls by 1 percentage point, the private consumption growth rate decreases by 0.16 percentage points. The FKI analyzed that the decline in housing sales prices leads to a decrease in private consumption due to the negative wealth effect.

The FKI assumed that the household loan reduction rate would steepen slightly from 1.2% in the fourth quarter of last year to 1.4% in the first quarter of this year and predicted the housing sales price change rate for the first quarter. Based on the housing price growth rate estimation model, it was predicted that housing sales prices in the first quarter of this year would fall by 2.98% compared to the fourth quarter of last year, which is expected to reduce the private consumption growth rate in the first quarter by 0.47 percentage points.

Choo Kwang-ho, head of the Economic and Industrial Headquarters at the FKI, said, "Recently, our economy is facing a significant downturn in export conditions, and even consumption, which has served as a safety net for the economy, is shrinking. Although the Bank of Korea faces great difficulties in conducting monetary policy due to high inflation and the possibility of additional rate hikes in the United States, it is necessary to consider the impact on housing prices and private consumption together when deciding the base interest rate."

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