© YONHAP News

The United States is showing signs of departing from its monetary tightening policy. The U.S. Federal Reserve decided to freeze its key interest rate during meetings on March 19 and 20. It will also slow the pace of its balance sheet reduction program aimed at absorbing a large amount of dollars in the market, with the goal of completely ending the program, known as “quantitative tightening,” at the end of September. 

Today, we’ll discuss the implications of these two decisions and their potential influence on the Korean economy with Kim Dae-ho, director of the Global Economic Research Institute. 

The Fed has held its benchmark fund rates steady in the range of 2.25 percent to 2.50 percent. What grabs more attention is the decision to end the Fed’s program to reduce the bonds it holds on its balance sheet in six months. The Fed purchased a vast amount of bonds to spur economic recovery from the 2007-2009 global financial crisis. In the course of “quantitative easing,” markets were flooded with liquidity, while the Fed’s assets inflated. But from two years ago, as a result of a well-running economy, the Fed tapered off this massive monetary easing program and refrained from asset purchases. 

As a result, stock prices fell along with some metrics used to measure the U.S. economy. U.S. President Donald Trump has complained of this latter part many times. Now, the Fed has once again decided to slow the pace of tightening from May and stop reducing its bond portfolio in September. The move is expected to ease complaints of the Fed’s asset reduction. 

The Fed’s decision makers voted unanimously to leave the key interest rate unchanged at a two-day meeting last week. They also indicated that their balance sheet runoff would end by September, some years ahead of schedule. What can be perceived as a dovish stance by the Fed meets widespread expectations of a monetary easing initiative. Moreover, the Fed projected no rate increases this year.  

Until last December, Fed officials forecast three rate hikes in 2019, a prediction that didn’t sit well on Wall Street. But after scaling hike projections back to just one or two this year in January, the Federal Open Market Committee in March said there will in fact be no increases at all this year. This is a far more eased approach than the one the Fed had just three months ago. Taking a closer look at the committee’s recent announcement, some analysts say it even hints at the possibility of a rate cut, which would be a major U-turn from U.S. fiscal policy dating back to December 2015. 

Fed officials have apparently adopted a wait-and-see approach, opening up the possibility that the rate will remain static the remainder of the year. 

In fact, continual rate increases and quantitative tightening have dampened investor sentiment in many parts of the world, including Korea. The Fed’s decision to pause any increases for the time being may bode well for the Korean economy.

The Fed’s turnabout is certainly good news for the Korean economy. The U.S.’s rapid rate increases have put Korea at a disadvantage, as Seoul finds it difficult to raise the domestic rate. 

The widening rate gap between Korea and the U.S. has increased foreign capital outflow from Korea, making local stock prices fall. As the U.S. has signaled no further interest rate hikes for the time being and has apparently even left the door open for lowering rates, Korea faces far less pressure to increase its rate amidst a sluggish economy. Korea could now even employ a money-easing policy to stimulate the economy. Thus, local economic decision makers are likely quite pleased with the Fed’s decision.

For Korea, the U.S.’s shift towards monetary easing reduces the risk of a rate reversal and gives Seoul more flexibility in the way it handles its domestic economy.

Last year amidst a strong U.S. economy, the U.S. Fed raised the base rate on a quarterly basis, and the rate difference between Korea and the U.S. widened to 0.75 percentage point. Leaving the U.S. interest rate higher than that of Korea may prompt foreign investors to move capital out of Korea at a time when Korea faces much economic uncertainty. That’s why, at least to some extent, the Bank of Korea should keep pace with the U.S. Fed in terms of rate increases. 

Encouraged by news about the Fed’s decision to maintain its key rate, the Korean stock market showed signs of bullishness last week. But the Fed’s move does not come without concerns. 

Rate hikes over the last four years by the U.S. have been a bottleneck for the global economy. Keeping rates steady will provide a much-needed boost to global financial markets. On the flip side, however, the Fed’s about-face suggests it believes trouble lies on the horizon for the U.S. economy. Both the Fed and the International Monetary Fund in fact have warned of an overall global economic slowdown. The Fed’s rate-freeze should be understood in this context, and stock markets may respond appropriately.

The U.S. seems to have concluded that further rate increases may accelerate an economic downturn at a time when the European and Chinese economies are also slowing. Indeed, geopolitical uncertainties have led central banks in many advanced countries to abandon tightening policies and move to invigorate their economies instead.

On March 7, the European Central Bank froze its policy rate at zero percent and announced a plan to introduce a new long-term loan program that would extend cheap loans to troubled financial institutions in the Eurozone. On a similar note, the Bank of Japan decided on March 15 to keep its key interest rate at minus zero-point-one percent and maintain its bond-buying program. 

Monetary easing policies like these observed around the world are expected to influence the interest rate adjustment in Korea.

In line with the U.S., the Bank of Korea may also adopt its own fiscal easing policy—possibly an interest rate reduction. But a rate cut may expand Korea’s already high household debt even further. The country’s ballooning household debt is an important factor the central bank takes into account when executing its rate policy. For now, it remains rather circumspect about any rate adjustment and will likely maintain a wait-and-see mode for some time. 

On March 21, Bank of Korea Governor Lee Ju-yeol said that it is not the right time to lower the interest rate. Moreover, Korea’s exports situation is not very good. Outbound shipments have decreased for the fourth consecutive month, due partly to a drop in semiconductor exports. 

Korea must evaluate the U.S. Fed’s decision objectively and with clear eyes. As the Fed’s rate freeze has given Korea some room to manage its monetary policy, Korea should thoroughly prepare for a slowdown in the global economy.