Dogs that must bark

Lee Jong-wha
The author, former chief economist at the Asian Development Bank and a senior adviser for international economic affairs to former President Lee Myung-bak, is a professor of economics at Korea University.

Governments around the world responded to the unprecedented Covid-19 pandemic crisis with record fiscal and monetary stimuli. They are being warned of the side effects from excessive spending and monetary stimulus from ultra-low interest rates as economies recover. The $1.9-trillion-stimuli package pushed by Joe Biden’s administration and Democrats for passage possibly in March has been met with concerns. Larry Summers, former Treasury secretary for Bill Clinton and economic adviser to Barack Obama, warned that Biden’s stimulus package can cause “inflationary pressures of a kind we have not seen in a generation, with consequences for the value of the dollar and financial stability.” The massive spending could fuel inflationary pressure if pent-up consumption is restored in line with the spread of vaccinations.

When inflation reached 13 percent in 1979, the U.S. Federal Reserve subdued it by yanking up the benchmark rates to 20 percent. Many argue that inflation won’t likely pose such a dire problem. In a recent Congressional hearing, Fed Chairman Jerome Powell dismissed those fears, saying that harmful inflation “doesn’t seem likely.” The International Monetary Fund (IMF) predicted the U.S. inflation rate at a passable level of 2.25 percent in 2022.

In a 2013 report, the IMF referred to subdued inflation — despite the ultra-loose monetary policy and quantitative easing programs by major economies to fight the 2008-2009 financial crisis — as “the dog that didn’t bark.”

The IMF pointed to changes in the economic environment such as weakened pressure on inflation with the global value chain keeping product prices low thanks to cheap Chinese labor, innovations reducing product costs and slowed rises in wages.

Central banks’ solid policies on inflation also helped contain it. Most central banks around the globe have been operating monetary policy aimed at keeping inflation at around 2 percent.

Given such changes, prices may not rise sharply. But some say this time could be different. The Covid-19 stimuli have put much more money in the market than in the aftermath of the 2007-08 global financial meltdown. If money supply is too great, the value of money would naturally fall.

Korea also has kept up fiscal and monetary stimuli. Its fourth round of relief payments amount to 19.5 trillion won ($17 billion). The government is pushing ahead with a colossal pork-barrel project of building a new airport on Gadeok Island off Busan at the cost of over 28 trillion won.

Many SOC projects have been approved even without feasibility studies, stretching national liabilities at a dizzy pace. The Bank of Korea has come under pressure to buy back government bonds to facilitate the government’s debt-financed stimuli.

But it is dangerous to think the government could turn to the central bank for unlimited lending. Countries like the United States with internationally trading currencies face lesser risks from a spike in government debt and monetary supply, as their currency value can be sustained thanks to unwavering demand for U.S. treasuries and greenbacks overseas.

Korea’s case is different. If the government issues too many national bonds, their prices will fall — and their yields can rise rapidly. If interest rates rise quickly under such circumstances, the government and households will have to bear a bigger financing burden to repay their debts. It is essential to defend a currency value at a certain level and keep financial markets stable for open economies like Korea. If international money rates go up soon, foreign capital can pull out, rocking the capital markets in Korea and the Korean won.

Government spending to cover for business losses from Covid-19 and to create jobs is necessary. But the stimulus must be focused on helping stabilize the economy while minimizing the future burden. Big-money projects with questionable effect and policies that can undermine the value of the currency must be avoided.

If people become addicted to giveaways by the government, populism will thrive. The policies being railroaded by the ruling party ahead of the elections should be discussed thoroughly with economy-related government offices and monetary policymakers. Government employees whose status are protected by the law must not yield to political pressure if they are more committed to the people and society. Academics, media and civic organizations must raise their voices to keep government policies in check. A muzzled dog cannot be relied on as a guard dog. Other guards must sound alarms to warn of serious consequences.