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Calming Inflation, Awakening Investment

U ncertainty being undoubtedly one of the most treacherous impediments to investment, the recent developments in US prices have shed renewed optimism on the global financial markets. To the relief of many, US consumer prices showed a definite sign of calming inflation in July. When the rate of CPI inflation year-on-year surged from 2.6 percent in March to 4.2 percent in April, it shocked not just ordinary laymen but all members of the Fed, who have to implement important monetary policies by adjusting the key interest rate, namely the federal funds rate.

Facing strong pressures to act against the April inflation data, the Fed played down the inflationary price movements as a short term transitory phenomenon following supply shock bottleneck on the one hand, and the base effect on the other. Indeed, the prices from April 2020 had fallen significantly due to the COVID-19 pandemic, rendering this year’s movement more exaggerated than otherwise. As the inflation data for the months of May and June had surged even higher to 5.0 percent and 5.4 percent, respectively, the Fed and the financial world began to worry about the stickiness of inflationary pressure, and were ready to cast doubt on the hypothesis of transitory inflation. The summer of 2021 was full of heated debates concerning the timing and size of future tapering, and the rate hike. Had the data for July shown an even faster rate of inflation, the Fed could not have rejected the idea of immanent tapering.

But, the CPI inflation for July remained the same level of 5.4 percent as June, and the core inflation rate fell from 4.5 percent in June to 4.3 percent in July. This small decline in the inflation rate, however, looms so large in the financial world as it is taken to prove the short term nature of the current inflation, and consequently, ordains the Fed’s adherence to the do-nothing principle. Of course, a higher than 5 percent CPI inflation rate is way above the long term average target rate of 2 percent, and the Fed cannot just sit down and continue doing nothing as it has done for the last 12 months. It has to do something and everyone knows it is going to be a scaled-down version of tapering, probably beginning this Fall. The asset purchase of USD 120 billion every month by the Fed will be reduced somewhat in the near future.

But this kind of a contained tapering schedule would not pose a serious threat to the financial world, and the financial markets would have all the room to absorb this kind of tantrum shock. Except for a few developing nations, the entire global financial venue will be able to adjust quickly to this change of environment as the year-old uncertainty of the Fed’s action evaporates. Despite slightly reduced global funds due to the Fed’s smooth tapering, and possibly a little higher interest rate for international investments, such a sound and prospering country like Korea will have little obstacle in inducing foreign funds for investment.

By Professor Se Don Shin
Professor Emeritus, 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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