[Viewpoint]Stepping out of the economic shadows

When asked who is the greatest economist of the 20th century, many would answer John Keynes. Nowadays even more people would say his name as the outlook for the world economy darkens.

Keynes and other economists who developed his theory left us a valuable lesson that when there is a large hole in the market the government must step in and fill that void. If there is a hole in the financial system the central bank should issue currency to fill it and lower interest rates to give breathing room to households and companies. However, if an economic slump is so serious that such measures wouldn’t revive consumption and investment, then the government must increase expenditure and fill the hole in consumption and investment.

The world is desperate for measures to stimulate the economy. The belief that the Great Depression wouldn’t happen again is based only on the fact that the world is firmly armed with Keynesian measures, unlike in the 1930s. Nevertheless, not every country can carry out measures to stimulate its economy. If a country whose currency’s purchasing power is weak abroad has a huge amount of short-term debt, a policy to stimulate the economy could just worsen the crisis.

Lowering interest rates has side effects. Cutting interest rates makes domestic bonds less attractive, making foreign currency leave the country and the foreign exchange rate go up. The money that the government borrowed to expand state expenditure will have to be paid back with taxpayers’ money. If the country’s tax-bearing capacity is weak, investors start to suspect that the state would issue more money to pay back debts. Investors would take back their capital immediately if they think consumer prices and the foreign exchange rate will likely rise in the near future. If we don’t have foreign currency to pay for imports that we need while exporting countries won’t take our currency, there is no way out of the crisis.

The United States and Europe wouldn’t have been able to carry out measures to stimulate their economies if they didn’t have the key currencies: the dollar and the euro. Experts on economic history point out that during the Great Depression advanced countries retrenched, the opposite of today’s policy, and ended up worsening the depression. But the purpose was to prevent gold, the standard of exchange at that time, from leaving their borders. Thus, Keynes and Harry Dexter White, the designers of the International Monetary Fund, recommended a system that limits the movement of international capital, in an attempt to expand member countries’ capacity to stimulate the economy.

Developing countries that have faced economic crises in the past few decades must improve their current account balances, raise interest rates and tighten their belts in order to satisfy the IMF. Amid the crisis, Hungary is reducing state expenditure, and raising taxes and interest rates. As for economic policies, there is sunlight in some places and there are shadows in others.

Where does Korea stand now? If Korea with its large foreign reserves and healthy government and company finances, is facing a crisis, the international financial system is surely at fault.

The international financial system had pressured emerging economies short on reserves, forced them to open their capital markets fully, making them heavily dependent on banks of advanced economies for supply of key currencies. As these banks ran into problems of their own, they withdrew their capital while shutting the door on emerging economies.

This is truly pathetic. But shameful and pathetic events have always taken place in history. And a financial panic means that investors are unable to discern real risk from its opposite.

When the media argued for preemptive reduction in the interest rate, dollar supply and drastic deficit financing, I felt nervous. I wasn’t sure whether Korea, a country that is neither in the sunlight nor in the shadow, could take the same measures as the United States and Europe did. In this regard, it is truly good that we signed a currency swap agreement with the U.S. Korea has just squeezed itself into the network of advanced countries and moved a step into the sunlight.

However, it is too early to feel relieved because exports next year are worrisome. If housing prices and stock prices fall by 30 percent, the volume of losses in properties will exceed the gross domestic product. Will the administration of each country be able to absorb the shock from such huge losses with state expenditure which accounts for a small share of the gross domestic product?

If the international financial markets aren’t restored soon and the growth rate of the global economy next year is way below 3 percent, our exports and current account will be threatened and a foreign currency liquidity crisis may occur once again. In preparation for this scenario, we should strengthen our key currency position.

If that is not easy to do, it will be wise to govern the economy conservatively, adjusting the degree of economic stimulation in accordance with export expectations and outlook in the foreign currency market.

The writer is a professor of conomics at Sogang University. Translation by the JoongAng Daily staff.

by Song Eui-young