[CON] Stay the course on fiscal integrity*Government must act to stimulate the economy
The Korean economy is sinking fast. GDP grew a mere 0.1 percent from the second to the third quarter, the lowest in three and a half years. At that rate, growth in 2012 is unlikely to meet the central bank’s downgraded 2.4 percent estimate. Yet the government has no stimulus plan, being primarily concerned with staying within its budget. But calls are getting louder for more aggressive action to boost the sagging economy before it’s too late. Here are both sides of the argument.
Efficient fiscal maneuvering is essential because of the economic ramifications of government spending and revenue. When the economy is in a downward spiral, authorities naturally are under pressure to loosen policy to stave off recession.
The theory behind fiscal stabilization is to act against the cyclical trend through budgetary spending in order to reduce volatility. When the economy slows, the government takes stimulus actions by increasing spending and cutting taxes. When overheated, it reduces spending and raises taxes. Current stagnation would naturally prescribe more spending.
But the economy’s current slowdown cannot be easily fixed through short-term countercyclical stimuli. Its troubles come from a double whammy of the prolonged global financial crisis exacerbated by European credit woes. Moreover, the crisis in Europe is an intricate problem involving the future of a single currency bloc and therefore cannot be resolved quickly. In short, the government is in for a long battle, and wasting its ammunition at this stage would be unwise. More spending despite bleak prospects for increased income is a bad habit for the state as well.
Current headwinds largely come from overseas, which means individual state stimulus action can prove vain. Increased liquidity could only accelerate the won’s appreciation. Increasing government spending could stoke the value of imports and local currency. Stimulus could revive some sectors, but fall short of accelerating the economy overall if exports fall due to a stronger currency. Current-account surplus is the key to credibility overseas, and if it worsens due to increased fiscal spending, the economy could lack resilience against external shock.
If the government increases spending before or after the election, the budget could go higher because various interest groups would demand their share. The budget could be victimized by the conflicts of interest by politicians in the process of appropriating resources.
In fact, budgetary authorities for the time being should keep a stricter eye on expenditures.
It does not mean there are no other policy alternatives to sustain the economy. Instead of resorting to fiscal stimulus, authorities should take more monetary actions to boost liquidity, primarily targeting a solution to the problem of household debt. Monetary policy does not have the same immediate effect on the economy as fiscal action. Benign interest rates could stir consumer and corporate spending or bring down the currency value to help export competitiveness. What is important now is keeping liquidity flowing and helping to relieve the household debt burden.
As expansionary fiscal policy increases deficit and debt, monetary easing, too, has its downside. It can stoke inflationary pressure. But rising prices to some extent could actually help at a time when real estate and other asset prices remain depressed. Inflation also helps to offset pressure from a strong currency. International markets mostly watch fiscal integrity in ratings and investing in sovereign debt since the credit crisis in the euro zone. Risking inflation would be a better choice now than a worsened fiscal state.
Considering the character and estimated period of economic slowdown, the political calendar and international financial market conditions, it is better for the country to uphold fiscal integrity based on expenditure and debt control instead of increasing spending. Any new policy instead should come from monetary authorities aimed at helping to reduce household debt.
*The author is a professor at the economics department of Yonsei University.
By Sung Tae-yoon