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Of all the global changes that the year 2022 will bring about, nothing would have more far-fetching and further-reaching an economic impact than the actions that the U.S. Federal Reserve System (the Fed, hereafter) would take under this tumultuous times. Considering its immense influence on global finance, exchange rates and interest rates, even a tiny butterfly swing from the Fed could have brought a gargantuan consequence on Wall Street with global consequences. It was not just a little sway of a bug, but a series of significant moves inside the Eccles building since the late Fall of 2021 that would arouse global concerns in coming years.
First of all, three new members of the Fed governors will be reappointed this year by President Biden, replacing the two resigning governors, namely Randal Quarles and Richard Clarida, and one filling the empty seat vacated by the current treasury secretary Janet Yellen who resigned in February 2018. One of the original appointees, namely Sarah Raskin, dropped out of the nomination, and the other two appointees await the already over-due senate confirmation vote. The two being Democrats, this process of confirmation will reshuffle the political landscape of the Fed from the Republican domination into the Democrats majority for the first time since 2017. More important than this political tint of the Fed is a fundamental hawkish shift in the Fed’s monetary policy under the second term under Powell’s leadership. Six months after the emergence of significant inflation since April 2021, the Fed openly decided to change its highly accommodative policy stance toward the so-called normalization process late November 2021. First step was to reduce monthly asset purchases by USD 15 billion from USD 120 billion to USD 105 billion. But that move was heavily criticized as it was a far cry in the face of skyrocketing inflation. In December 2021, the Fed doubled the reduction of the asset purchases from USD 15 billion to USD 30 billion, and discussed in detail about the future changes in the monetary policy. After the minutes were first revealed in January 2022, the global financial markets plummeted after realizing the dedication of the Fed to fight inflation. The Fed had seriously discussed the normalization process, and its implications were very clear. To curb inflation, the Fed decided to end accommodative asset purchases by March 2022. Soon after, it raised its policy interest rate by 0.25 percent in more than three years, and soon was followed by the rundown of the Fed’s balance sheet.
The critical point here is the number of the rate hikes this year and when the initial rundown will start. The majority of market analysts believe there will be at least six more rate hikes in 2022, rendering the federal funds rate almost to 2.0 percent by the end of the year. With this higher rate, global market rate hikes will also follow suit, and the dollar will become very strong, especially against the currencies of the developing countries. For sure, higher global interest rates will dampen demands and investment, making economic growth and trade volumes slow down substantially. But the negative effect of higher rates and reduced demand will be significantly contained if companies are fully prepared by technological competitiveness, and the governments with adroit fiscal policies.
For Korea, the second term of the current governor of the Bank of Korea expired at the end of March 2022, and a new governor was named. The new governor position will face a series of challenging tasks of fighting inflation, crumbling domestic demands, higher borrowing costs, and stabilizing housing prices. With the expectation of the Fed’s rate hikes this year, the BOK cannot avoid harmoniously paralleling its policy rate, but the crucial question is how far the BOK can catch up with the Fed’s rate hikes this year. If the Fed is to raise 1.5 percentage points this year to the 1.75-2.00 percent level, the BOK’s policy rate could reach 2.75 percent or even higher. It is not clear at this juncture how the BOK will react to the Fed’s rate policy, but the BOK can’t totally disregard the FOMC rate hikes, especially in view to stabilize the value of the Won. Whoever be the skipper of the BOK, significantly higher rate of interests should be esteemed by the markets.
Another big change in Korea in 2022 is the inauguration of the new president and new government. Although President-elect Yoon Suk-yeol emphasized integration right after winning the election, his strong message to the markets was the reconstruction of a free-market system and all-out deregulation. With incessant persistent intervention with the markets, the new government believes the previous government had been excessively interfering with efficient operations of the market system, discouraging the entrepreneurial spirit and investments. The outcome of the extraordinary interventionism was the lack of growth, job opportunities, and disparaged corporate vitality. Increasing number of firms left abroad, and fewer foreign investments landed on domestic soils. The potential growth rate has fallen below 2 percent, amid inflation rate is expected to hover above 4 percent. A quarter century feat of a trade surplus is about to be challenged by skyrocketing commodities prices for the first time since 1998. To no one’s surprise, the new government will reinforce the once forgotten free market spirit with continual deregulation, stabilizing prices and expanding job opportunities. More houses will be built, while tax burdens will be substantially reduced. Corporate reshoring will be welcome and extra incentives will be provided. The policy goal is more than ever evident.
The matter of the crux is how to get it achieved. All the governments in the past knew the importance of the market mechanism, free corporate spirit and deregulation. However, very few governments had actually achieved what it had originally designed ahead, due in part to failing to recognize formidable invisible tumbling obstacles. Sometimes by the resistance from the labor union, or by political objection, personal prejudice, or simply because of the withered disinterest from the political leaders, the mantra of deregulation has more often failed than otherwise. The deregulation with revision of the legislations seem especially difficult under the current congressional dominance by the opposition party. The nitty gritty of deregulation lays in successfully persuading the opposition party members with undeniable vision for the future. To accomplish a vision of building a technologically world-leading country, Korea may need a huge bulk of investment funds, an army of well-trained human resources, a plank of super charged education and research institutions, and efficacious policies by the administration. All of these require tenacious Copernican removal of old regimes and regulation. Without tenacity and Copernican iconoclasm on the part of the new government, its deregulation pledge will end up much cry with little wool. Realizing the importance of this future vision, it is natural to hope all the political authorities come up with sweeping harmony for the betterment of the nation.
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