[Insight & Opinion] AI Optimism and Korea's Interest Rate Dilemma

Asset Overheating and Financial Imbalances Challenge the Bank of Korea

Concerns Over Prolonged High Interest Rates Amid Fears of a 'Second Dot-Com Bubble'

One of the most intriguing developments in the global financial markets recently is the ongoing debate over "how artificial intelligence (AI) will affect interest rates."

Traditionally, technological innovation has been believed to boost productivity and push down prices. Indeed, the spread of the internet and automation technologies has contributed to reducing inflationary pressures in the long term through cost savings and expanded supply. However, the current AI boom is somewhat different. At least in the short term, there is a high possibility that AI will actually prolong a high interest rate environment.

Federal Reserve Chair Kevin Warsh has recently become somewhat more cautious regarding monetary policy in the age of AI. He previously emphasized that AI could boost productivity and provide room to lower interest rates. However, he has recently acknowledged that, in the earlier stages, it could also lead to massive investment expansion and overheating of asset markets. In fact, the U.S. stock market has already responded strongly to expectations related to AI. Share prices of companies in semiconductors, data centers, cloud computing, and power infrastructure have soared, and overall market valuations have also risen.

The problem is that this phenomenon is not confined to mere changes within the financial markets. The AI industry requires far more real-world investment than previous information technology (IT) innovations. Notable examples include large-scale capital expenditures for building data centers, expanding power grids, producing high-performance semiconductors, and constructing cooling facilities. This strongly stimulates aggregate demand. Companies expand investment in anticipation of future growth, which can lead to rising asset prices and increased consumption. As a result, the economy as a whole faces the risk of rapid overheating.

The Korean economy may be particularly sensitive to these changes, especially because the nation has a high proportion of industries closely tied to AI infrastructure, such as semiconductors, electrical equipment, and batteries. If the AI investment cycle enters full swing, there is a strong likelihood of positive impacts on exports and corporate profits. In fact, expectations for AI-related semiconductor and power equipment companies have been rising rapidly in the domestic stock market recently.

However, there are concerns about potential side effects. The Korean economy already has high household debt and a distinctive asset structure heavily reliant on real estate. Recent sharp increases in stock prices, the expansion of leveraged investment, rising household loans, and concerns over real estate price hikes in certain regions all point to the risk that expectations for AI-related companies could spill over into financial imbalances. If AI optimism pushes up not only stock prices but also real estate prices, the risk to financial stability could be heightened. Asset price increases would in turn lead to more borrowing, further fueling overheating in consumption and investment. In this scenario, the Bank of Korea would find it much more difficult to keep interest rates low, given it would need to consider not only inflation but also financial imbalances. Additionally, with the won-dollar exchange rate already high, if the U.S.-led AI investment boom strengthens the dollar or puts more downward pressure on the won, this could pose an additional burden for the Korean economy.

The linkage with U.S. interest rates has become especially important. If the United States maintains higher interest rates for longer than expected, or even keeps the door open for further tightening due to the AI investment boom, overheating in asset markets, and rising power and infrastructure costs, it will be difficult for Korea to lower its own rates quickly and independently. A widening interest rate gap could increase downward pressure on the won and capital outflow risks. As a result, Korea may also have to endure high interest rates for a substantial period.

Of course, in the long run, if AI boosts productivity, reduces labor costs, and expands supply capacity, price stability may eventually be achieved over time. The issue lies in the transition period. Currently, the market is pricing in future expectations much more rapidly than actual productivity gains. This is reminiscent of the initial phase of the dot-com bubble in the late 1990s. At that time, expectations for technological innovation first drove up asset prices, and central banks had to worry about both economic overheating and instability in the financial markets.

The AI era is not merely an age of technological innovation. It is also an era that will once again test the balance between asset markets, monetary policy, and financial stability. The Korean economy now faces an environment in which it is no longer possible to focus only on economic slowdown when considering interest rate policy. While AI presents opportunities for future growth, it also carries the risk of creating a new form of high interest rate pressure.

Kyuil Kim, Professor at Michigan State University, United States

This content was produced with the assistance of AI translation services.