High Interest Rates, Low Interest Rates, and the Mechanics of Capital Expansion(From a Korean Economic Perspective)

1. Overview

Interest rates play a pivotal role in the global economy. Often referred to as “the return on capital,” interest rates influence how quickly capital generates income. Higher interest rates accelerate this process, while lower rates slow it down. In Korea and other countries, interest rates are adjusted based on inflation, economic growth, and global financial trends. But can the current high-interest-rate trend last? How do low-interest-rate environments shape economies? This report dives into the connection between interest rates and capital, their impact on production and labor, and their implications for Korea’s economy.

2. The Relationship Between Interest Rates and Capital

1. Interest Rate = Return on Capital
   • Higher interest rates lead to faster capital expansion.
   • Lower interest rates moderate the speed of capital growth.
2. Capital Income vs. Labor Income
   • High interest rates can widen the gap between capital income and labor income.
   • This potentially increases inequality, with capital owners benefiting more than wage earners.
3. Interest Rates and Money Supply
   • A rate hike may temporarily reduce liquidity in the market (circulating money).
   • However, in the long run, higher rates can increase total money supply through compounded interest

3. Why High Interest Rates Can’t Last

1. The Challenge of Sustaining Growth
   • Production relies on a balance between capital and labor.
   • When capital expands disproportionately due to high rates, labor’s value diminishes, disrupting production.
2. Limitations During Recessions
   • Extreme conditions (e.g., COVID-19 pandemic) might justify short-term rate hikes to curb inflation.
   • However, maintaining high rates during a recession reduces liquidity, while total money supply grows faster, leading to asset inflation and declining purchasing power for everyday citizens.
3. Inflation Without Growth
   • Without corresponding growth in production, high interest rates drive up total money supply, increasing prices without improving the standard of living.

4. Differentiating Capital, Assets, and Labor

1. Capital
   • Financial assets like cash, stocks, and bonds that flow freely across borders.
   • High interest rates fuel faster capital growth.
2. Assets
   • Fixed resources like real estate, which lack the liquidity of capital.
   • Asset value growth depends more on future appreciation than immediate high returns.
3. Labor
   • Human resources required for production.
   • Unlike capital or assets, labor is less fluid but can be imported/exported in specific contexts.

Understanding these distinctions helps clarify why capital benefits more from high interest rates than assets or labor.

5. The Impact of Interest Rates on Economic Policies

1. Market Liquidity vs. Total Money Supply
   • Rate hikes might reduce circulating liquidity in the short term.
   • However, compound interest ensures total money supply grows faster over time.
2. Stabilizing Prices vs. Asset Inflation
   • High interest rates can stabilize short-term prices but may drive long-term asset inflation.
   • This benefits those with capital, widening the wealth gap.
3. Effect on Everyday People
   • High rates increase loan repayment burdens for ordinary households.
   • At the same time, capital owners benefit from rapid asset growth, deepening socioeconomic divides.

6. Implications for Korea

1. A Balanced Approach to Policy
   • Policymakers in Korea must weigh inflation control against broader goals like economic growth and production.
   • Prolonged high interest rates during recessions could stifle job markets and production.
2. Interest Rates and Real Estate
   • Conventional thinking suggests higher rates lower real estate prices due to increased loan costs.
   • However, real estate, as a fixed asset, often aligns with long-term money supply growth, potentially driving prices up in the future.
3. The Importance of Economic Basics
   • By understanding the basics—“interest rates = return on capital”—investors and policymakers can make more informed decisions.
   • Avoid being swayed by short-term market noise; focus on long-term fundamentals instead.

7. Conclusion

While high interest rates might temporarily tame inflation, they risk destabilizing production and labor markets by fueling excessive capital expansion. Prolonged high rates are unsustainable, especially during economic downturns. Korea’s policymakers must strike a delicate balance between controlling inflation and supporting long-term growth. By mastering these concepts, individuals and institutions alike can navigate economic challenges more effectively.