Does my loan interest rate change based on the U.S. benchmark rate? Let’s explore how decisions made by the U.S. central bank across the Pacific affect our economy and loan interest rates!
The Power and Secrets of the Central Bank
“Don’t Fight the Fed.”
On Wall Street in New York, which holds the global financial markets and investment industry in its hands, there is an old adage like the one above. The central bank, or ‘Fed’, is short for the Federal Reserve System. Korean media often uses the term ‘U.S. central bank’ instead of ‘Federal Reserve System’. The fact that Wall Street investors, who control the global economy, use this expression as a maxim shows just how much power the central bank holds. So how exactly does the U.S. central bank exert its influence, and what is the secret behind such power?
The U.S. Central Bank Setting the Benchmark Interest Rate
The secret to its power lies precisely in its authority to set the benchmark interest rate. Like central banks in other countries, the U.S. central bank has the authority to set the benchmark interest rate and determine the money supply—that is, how much more money (dollars) to print. Think of it like Korea’s Bank of Korea. However, the power of the U.S. central bank is incomparably greater than that of any other nation’s central bank. This is because the currency whose issuance they control is effectively the world’s common currency: the dollar. The amount of dollars circulating globally increases or decreases based on the decisions of the U.S. central bank.
The U.S. central bank has several methods to regulate the amount of dollars released into global markets. In this blog post, we will examine one of those methods: the benchmark interest rate. In most countries, an independent central bank sets the benchmark interest rate. This rate refers to the interest rate the central bank charges when lending money to private banks and financial institutions within that country. In other words, it’s the rate determining how much interest the central bank receives when lending to private banks and financial institutions. You might find it surprising that banks, which you thought only lent money, also borrow money. When borrowing from the central bank, they must pledge their assets as collateral and pay interest. The interest rate owed to the central bank at this time is the benchmark interest rate. Globally, very few banks exist that cover the loans of countless borrowers using only their own capital. Banks lend to borrowers using money deposited by other customers and money borrowed from the central bank. They then offer the benefit of deposit interest to the customers who deposited their money.
Think of it as banks re-lending the money borrowed from the central bank to their customers. Therefore, when the base rate rises, the interest rate banks charge customers on loans also increases. The cost incurred by banks in obtaining the money they lend to customers is called the funding cost. When the base rate rises, the funding cost also increases, inevitably leading to higher loan interest rates. Conversely, when the base rate falls, the funding cost decreases, and loan interest rates also decrease. This is why you occasionally see critical articles in the news pointing out that banks are quick to raise lending rates when the base rate goes up, but very slow to lower them when the base rate falls.
By adjusting the base rate, the central bank can determine the amount of money circulating in the market, or simply put, the money supply. When interest rates rise, the interest burden on individuals and businesses borrowing money increases, leading to fewer people seeking loans. Conversely, when interest rates fall, the interest burden decreases, leading more people to seek loans. Therefore, when the economy enters a downturn, the central bank lowers the base rate to stimulate personal consumption and corporate investment. Conversely, when the economy is deemed to be overheating excessively and bubbles are beginning to form, the central bank raises the base rate to encourage a reduction in personal consumption and corporate investment. This is why the U.S. central bank, which determines the supply and demand of the globally used currency, the dollar, wields such immense power.
Korea and the U.S. Base Interest Rates
The U.S. central bank determines its base interest rate through the Federal Open Market Committee (FOMC), which meets eight times a year. The FOMC consists of 12 members, including the Chair of the U.S. central bank. In Korea, the Bank of Korea sets its benchmark interest rate through the Monetary Policy Committee meetings held eight times a year. Seven members, including the Governor of the Bank of Korea, participate in these meetings. Every time the FOMC meeting where the U.S. benchmark interest rate is decided convenes, it draws intense global media attention because the U.S. benchmark interest rate has a massive impact on global financial markets and the investment industry. Global stock, bond, and real estate prices fluctuate dramatically depending on how much dollar liquidity is injected into the market.
Over the past decade, the U.S. benchmark interest rate remained at an abnormally low level. This was due to the unprecedented emergency measures (zero interest rate policy) implemented to overcome the global financial crisis that erupted in 2008. The global financial crisis dealt a severe economic blow to major nations, including the United States. To combat the economic downturn, the U.S. central bank employed a zero-interest-rate policy from 2008 to 2015, keeping the benchmark rate at 0% for a full seven years. The idea was to stimulate consumption and investment through lower rates, thereby keeping the engine of economic growth running smoothly. This was a radical and unprecedented policy.
During the same period, Korea also had no choice but to follow the U.S. and other major developed nations in lowering interest rates. Korea’s benchmark interest rate also fell to around 1%, keeping loan rates, such as mortgage rates, at very low levels. Simultaneously, deposit and savings account interest rates also dropped significantly. The notion that saving money in banks couldn’t even keep pace with inflation was a direct consequence of the U.S. zero-interest-rate policy.
After the global economy gradually recovered from the shock of the global financial crisis, the U.S. economy returned to a normal growth trajectory. Accordingly, the U.S. Federal Reserve (Fed) ended its zero-interest-rate policy in December 2015 by raising the benchmark interest rate to 0.25% for the first time in seven years. Subsequently, in line with the economic recovery, it gradually raised rates until 2018, with the benchmark rate reaching 2.25–2.50% by December 2018. However, in 2019, influenced by global economic slowdown and trade conflicts, three rate cuts were implemented, adjusting the rate to the 1.50–1.75% range.
When the U.S. economy suffered a major shock due to the COVID-19 pandemic in 2020, the Fed implemented two emergency rate cuts in March, lowering the benchmark rate back to 0.00–0.25%. The zero interest rate policy remained in place until 2021. However, as inflation intensified in 2022, the Fed raised rates seven times from March to December, pushing the rate up to 4.25–4.50%. Additional hikes occurred in 2023, pushing rates to 5.25–5.50% by July, after which they were frozen while economic indicators were assessed. In 2024, citing economic slowdown and stabilizing inflation, the Fed began quarterly 0.25 percentage point cuts starting in July, reaching 4.00% by December 2024.
Meanwhile, the Bank of Korea began raising its benchmark interest rate in August 2021, making several adjustments through 2022, but has kept it frozen at 3.50% since February 2023. Consequently, the interest rate inversion between Korea and the US persisted, continuing for 31 months as of February 2025. While an inverted yield curve typically increases the likelihood of foreign investors withdrawing funds from the Korean market, the Korean government assessed the risk of large-scale capital outflows as low. This is because foreign investors consider not only the interest rate differential but also the performance of Korean companies and the overall market outlook.
In 2024, the Bank of Korea implemented interest rate cuts, considering the slowing economic growth and the stabilization of inflation. On October 11, it lowered the base rate by 0.25 percentage points from 3.50% to 3.25%, marking a shift in monetary policy stance for the first time in three years and two months. Subsequently, on November 28, it cut the rate by an additional 0.25 percentage points, bringing the base rate to 3.00%. During the same period, the U.S. also lowered its benchmark rate by 0.50 percentage points to 5.00%, slightly narrowing the interest rate gap between Korea and the U.S. However, the inverted rate situation persists.
Experts predict that the Bank of Korea is likely to gradually lower rates following the U.S. trend of rate cuts. However, the extent of rate cuts may be limited due to concerns over rising household debt and overheating in the housing market. The Bank of Korea must take a cautious approach when making monetary policy decisions, comprehensively reviewing both the Korean economic situation and external factors.
While the recent Bank of Korea rate cut has somewhat eased household interest burdens, persistently high household debt levels remain a major burden on the economy. In September 2024, the Bank of Korea’s household loan balance reached 1,130 trillion won, an increase of 9.3 trillion won from the previous month, marking the largest monthly increase since July 2021. In October 2024, the base rate was lowered by 0.25 percentage points. This is expected to reduce the annual interest burden for household borrowers by approximately 3 trillion won. However, since a significant portion of loans are variable-rate, the household burden is likely to increase again depending on future interest rate fluctuations.
Particularly for mortgage loans, which are linked to the COFIX rate, an increase in the base rate will cause loan rates to rise as well. This could exacerbate household repayment burdens, reduce consumption capacity, and negatively impact the overall economy. Therefore, the Bank of Korea must closely examine the scale and structure of household debt and seek ways to minimize financial burdens. Furthermore, the government and financial institutions must continue policy efforts, such as strengthening loan screening and enhancing repayment capacity, to maintain the soundness of household debt.
