The Monetary Policy Committee is holding its monthly meeting Friday to determine whether or not to keep the central bank’s benchmark rate intact. Among the things that must be taken into consideration is the real interest rate, which has remained below zero for the past five months.
A key real rate, the nominal yield on three-year government bonds less the consumer price index, was minus 0.5 percent in April. The difference was twice as large in March. Simply put, bondholders were sustaining losses on their investments. The actual losses were even greater, given the 15.4 percent tax on nominal interest income.
In times of a slump, the Bank of Korea may have good reason to tolerate a negative real rate, which provides consumers with an additional incentive for spending. But to keep the real rate below zero for a prolonged period does much more harm than good.
The negative real rate will certainly lower the household savings rate, which stands at an abysmally low 2.8 percent ― half that of the United States. It will encourage households to borrow and spend at a time when their debt level is dangerously high ― 1,000 trillion won. What about the plight of retirees who live off their savings?
The harm is not limited to households or individuals. A prolonged negative real rate will also help create bubbles in equity and property markets. When they burst, it will send the economy into a tailspin.
This is not to say that the central bank has been standing idly by. It has raised its benchmark rate on four occasions since last July, from 2 percent to 3 percent. But it has not been enough to reverse the negative real rate. This gives the central bank ample reason to take bolder action this time.