It is economic sluggishness combined with high inflation.
The word “stagflation” is all over newspaper pages and TV news these days. Your parents may have also been complaining about it. But what does this odd word mean?Stagflation is actually a portmanteau, a word created by putting two words together. The “stag” part comes from the word stagnation, which means of failing to develop or advance. The “flation” part comes from inflation, which is the continued rise of prices in an economy.
Let’s see why this word has been appearing in the media so frequently lately. When the United States went through the Great Depression in the 1930s, mainstream economists believed in the economic theories of John Maynard Keynes. He said that if the economy deteriorated, it would set off a chain reaction. The number of jobless people would increase, making people unable to spend. Thus, demand would fall, causing product prices to drop as well.
The Keynesian theory fell out of favor, however, during the 1970s. The event that sparked this change of thought was the first oil crisis that followed the 1973 Arab-Israeli War.
In the United States, the price of international crude oil soared amid the war in the Middle East. As a result, the price of various goods and services also surged. This happened because many goods and services use oil as fuel or a raw material. Their profitability deteriorated sharply due to rising raw material and fuel costs. A lot of companies, as a result, went bankrupt. At the same time, a lot of people lost their jobs.
Keynesian theory held that people losing their jobs would lower prices and make the economy deteriorate. But during this crisis, inflation shot up, which also caused the economy to deteriorate. This result contradicted Keynes’ ideas.
The current economic situation is similar to that of the 1970s. For the last year, international crude oil prices have doubled. This has also caused a hike in the prices of raw materials such as iron, copper, nickel, corn, wheat and beans. This rise in prices is happening because emerging economies such as China and India have sharply expanded their demand for such products, and suppliers can’t keep up with such high demand. The less supply of a commodity, the higher the price.
In addition, speculators are snapping up these products on the expectation that the prices will rise more. Thus, prices are rising faster. To make matters worse, the price of Chinese goods, which had lowered the world’s average prices due to their low costs, has begun to rise sharply.
This isn’t the end of the story. From the early 2000s, the United States has lowered its interest rate to boost its economy. The U.S. government had intended to boost the economy through the rate change, on expectations that companies and consumers would borrow money at low interest rates and, with more money, would increase investment and consumption.
But problems related to low interest rates soon grew visible. People with bad credit took out mortgages to buy homes because they could afford to do so with low interest rates. They could borrow enough money to buy a house, and then slowly pay off their debt without being charged high interest rates.
Because these people bought homes under circumstances that were less than ideal, their mortgages were called subprime, as in less than prime. Eventually, some of these homeowners began failing to make payments on their subprime mortgages.
Because potential homebuyers could easily get mortgages from banks to buy houses, more people purchased real estate. As a result, housing prices rose. As home prices climbed, more and more people rushed to get subprime mortgages to purchase houses and buildings. Then, the Federal Reserve Board, which is the central bank of the United States, began to raise interest rates to curb home price hikes and general inflation. When too much money is circulating, its value shrinks.
House prices began to tumble. Many people defaulted on their loans, or failed to pay them off. The price of houses declined, and the financial service companies, which had provided the mortgages, could not cover the losses due to the high number of defaults.
A lot of financial service companies went bankrupt. Even global banks such as Citibank suffered huge losses amid the subprime mortgage crisis.
Banks began to tighten their loan provisions. Now that it’s become difficult for companies to get loans, companies are reducing their investments. Consumers are also tightening their expenditures, because they have to repay their debts. Now tell-tale signs of economic recession are rearing their head in the United States. The country is now facing the danger of stagflation for the first time since the second oil crisis in 1979, about 30 years ago.
What about Korea? The Korean economy has been relatively stable since the 1997-98 financial crisis. Due to cheap Chinese imports and foreign labor, prices have generally stayed low. But with the international prices of crude oil and other raw materials surging, the Korean economy is not so safe. In addition, Korea imports most of the raw materials it needs.
As the import prices have surged, the year-on-year growth of the nation’s consumer prices has exceeded 3 percent in five consecutive months.
The Lee Myung-bak administration says its top priority is stabilizing prices. In addition, some signs of economic sluggishness are showing. If the economy continues to sour, many economists warn that Korea will also see stagflation.
How can Korea weather these difficult times? Economists say stagflation is a difficult disease to cure. If the country lowers interest rates to boost the economy, then the prices of goods and services will rise, because more money will pour into the market.
On the other hand, if the country raises interest rates to curb price hikes, the condition of the domestic economy will deteriorate. Debts will batter consumers and companies. For this reason, monetary policy authorities are now in a dilemma.
Is there a way to improve Korea’s economic conditions other than raising or lowering interest rates? It’s hard to say at this time. But if you look back at the United States and the United Kingdom in the 1970s, you can see that these countries raised interest rates at first to curb inflation.
Then they cut taxes to encourage rich people and firms to increase consumption and investment. These changes resulted in economic success. So what would you do as president? It’s a complex issue, and offers plenty of food for thought.
By Kim Jun-hyun JoongAng Ilbo [symoon@joongang.co.kr]
with the Korea JoongAng Daily
To write comments, please log in to one of the accounts.
Standards Board Policy (0/250자)