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[Economic Opinion] Deflation, Deja Vu

Right after the bureau of statistics in Korea announced that the consumer price index (CPI) for the month of August had fallen 0.038 percent over the year period, it shocked the people and the possibility of deflation once again became one of the hottest buzzwords of the times. Many analysts even jumped to the conclusion that Korea is in a state of de facto deflation, as had Japan been for more than a decade since the late 1990s. Deflationists emphatically argued that the clue was not the single month fall in CPI, but the GDP deflator falling quarters since the fourth quarter of 2018.

The fuss about deflation is not entirely new. It is the deja vu of September 2014, when two-thirds of 30 scholars surveyed believed that Korea was in danger of deflation, with varying degrees of certainty. In retrospect, however, neither 2014 nor afterwards was found to be a deflation. The advocates were just found to be dancing with the then government, including the Ministry of Strategy and Planning, which had long wanted to find a rationale for drastically easing the monetary policy and stimulating construction businesses. For the ministry, deflation was a sure enough excuse to legitimize dramatically lowering the interest rate as well as to engage in massive stimulative fiscal policy measures, which eventually plagued the economy with the real estate bubble without much of the desirable real effects. And this time again, the deflationists’ subscription is exactly the same; they want the authority to lower the interest rate further down with massive stimulative fiscal policy.

A deflation is a real danger, especially when it is caused by chronically sluggish real demand. A dampened real economy pulls down demand and prices, followed by faltering real growth which once again invites another round of a fall in demand and prices. This is called the deflationary spiral, which overwhelmed the world under the name of the infamous Great Depression in 1930s. A recent example of deflation could be found in Japan when it suffered negative inflation with little economic growth for more than a decade since 1999.

A textbook causes of deflation consist of demand oriented as the 1930s and Japan in the 2000s, or oversupply, or monetary contraction. Even if the Korean economy has been sluggish for some time, it has mostly maintained positive growth rates. Therefore, demand deflation is a far cry. As the base money has been expanding well over 9 percent, monetary deflation is also unimaginable.

Looking at the micro statistics, it becomes ever more evident that the recent fall in prices are coming from the decline in some of the key service prices and fresh produce such as vegetables and fruits. More specifically, the prices of communication services (-2.2%), transportation (-1.9%), and grocery produce (-3.6%) showed falls in August. Indeed, the prices of almost all fruits and vegetables have fallen between 15 percent and 54 percent for the month, due to extraordinary harvest. The prices of communication and transportation have been managed under strict guidelines by regulatory agencies, implying that the fall is not a continuous but a transitory phenomenon. On top of this, Korean growth rates in real economy or domestic consumption are relatively low and declining, but never close to zero or below. All of these sheer facts are leading us to believe that this recent fall in some of the price indexes is, as the Bank of Korea and the Ministry of Economy and Finance explain, all but a transitory consequence of either seasonal oversupply or governmental guidelines. This means that the price fall will soon halt and there will be no further concern.

But that doesn’t mean that there is no need for worry at all. One of the incumbent ailments is the chronically falling global prices of raw materials and agricultural commodities. The prices of petroleum, copper, wheat, aluminum and cotton are simultaneously falling more than 10 percent for the year. Reflecting the global economic slowdown, demands for the products have been weakened for more than a few quarters, bringing speculative futures prices further down. The potential recession in Europe, China and the U.S. will render further down in their prices, creating a pandemic disinflation on a global scale. Many analysts in the U.S. have begun to worry about the re-emergence of the Great Recession.

However, one of the most comforting or relieving strengths in times of potential future difficulty is its fiscal integrity. The national debt to GDP ratio is below 40 percent, one of the lowest among OECD countries. Korea has plenty of leg-room to deal with potential economic and financial turmoil with the government’s fiscal and monetary maneuverability: it can directly issue government bonds or have the Bank of Korea supply sufficient money with government collateral.

To reinvigorate the business spirit, various measures can be considered. Broad based deregulation is one significant way to relieve business leaders out of their hopelessness. Also, lowering or delaying inheritance tax is another good way to hype-up their conviction in the future business. Whatever that might be, something should be done immediately to let businesses rise up again for the country.

By Professor Se Don Shin
Dean, Sookmyung Women’s University

The opinions expressed in this article are the author’s own and do not reflect the views of KOTRA

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