(EDITORIAL from Korea JoongAng Daily on Aug. 28)

The Bank of Korea increased its benchmark interest rate from 2.75% to 3% on Thursday, marking a second consecutive monthly hike as part of its efforts to curb inflation. This move is unusual because central banks typically wait to see the effects of one rate increase before taking another. The economy is showing clear signs of tightening monetary policy.

Consumer inflation stayed above 3% in May and June, though it slightly decreased to 2.8% in July but is still above the central bank's 2% target. Geopolitical tensions in the Middle East and increasing demand-side pressures have made it more likely that high inflation will continue. The Bank of Korea predicts that the economy will grow by 3.3% this year and 2.9% next year, with core inflation expected to reach 2.5% in both years.

Bank Governor Shin Hyun-song argued that preemptively addressing inflation could ultimately lower overall economic costs. However, the impact of the 3% benchmark rate could be significant. As the gap between exports and domestic demand, and between large corporations and smaller businesses, widens, higher borrowing costs will disproportionately burden vulnerable parts of the economy and deepen economic inequality.

With household debt already exceeding 2 quadrillion won (US$1.45 trillion), those who took on significant debt to purchase homes and self-employed business owners could find themselves nearing their financial limits. The government needs to implement macroprudential measures and targeted policies to safeguard vulnerable borrowers.

The disconnect between monetary and fiscal policy is another concern. While the Bank of Korea is tightening liquidity, the government has indicated that its budget for next year will exceed 800 trillion won (US$580 billion). This fiscal expansion could undermine the monetary tightening efforts and prolong the hardships for households and businesses.

The yield on Korea's 10-year government bond has risen to 4.27%, signaling a market concern. The government should heed this signal and refrain from implementing aggressive fiscal policy when the central bank is raising rates to control inflation. Otherwise, policymakers may inadvertently force interest rates to remain higher for longer and increase financing costs throughout the economy.

To reduce uncertainty and restore coherence to economic policy, the government should avoid using higher-than-expected tax revenue as an excuse for indiscriminate spending. Instead, it should use additional fiscal resources to proactively repay national debt.