KDI "Expansionary Fiscal Policy Fuels Housing Price Increase... Impact Expected at Least Until Q1 Next Year"

Report on the Ripple Effects of Increased Money Supply and the COVID-19 Economic Crisis

Increase in Money Supply Due to 'Base Rate Cuts and Four Supplementary Budgets' in Response to COVID-19
Money Supply Increase → Short-term Rise in Housing Prices with Inelastic Supply

"Policies Restricting Housing Supply Expansion Should Be Avoided"

[Sejong=Asia Economy Reporter Joo Sang-don] An analysis from a government-funded research institute revealed that the government's expansionary macroeconomic policies in response to the novel coronavirus infection (COVID-19) increased the money supply in the market, which ultimately led to a short-term rise in housing prices.

On the 9th, Jeong Dae-hee, a research fellow at the Economic Strategy Research Department of the Korea Development Institute (KDI), released a report titled "The Ripple Effects of Increased Money Supply and the COVID-19 Economic Crisis" containing these findings.

The Bank of Korea's two rounds of base rate cuts, the government's emergency liquidity supply policies responding to the COVID-19 shock, and the formulation of four supplementary budgets rapidly increased the money supply. Accordingly, the year-on-year growth rate of broad money (M2), which represents the overall money supply in the economy, recorded a high increase from 8.1% in the first quarter to 9.7% in the second quarter of this year. It also rose by 10.0% and 9.5% in July and August, respectively.

Research fellow Jeong said, "An increase in money supply temporarily expands overall economic demand, stimulating economic activity and raising prices, but these effects vary depending on sectoral characteristics. In the short term, the higher the price elasticity of supply, the greater the increase in quantity rather than price, and the lower the price elasticity of supply, the greater the increase in price rather than quantity."

In other words, in the housing sector, where supply inevitably responds inelastically to price increases when the money supply rises, production may not improve while prices rise rapidly. Jeong emphasized, "When the money supply increased by 1.0% due to a monetary supply shock, the GDP deflator, a comprehensive price index reflecting all economic activities affecting national income, rose by about 0.5% over eight quarters. In contrast, housing prices increased by about 0.9% over four quarters, showing a response about twice as fast and large as the GDP deflator."

Considering that the Bank of Korea first lowered the base rate in March this year and the government formulated the first supplementary budget in April to respond to COVID-19, the upward trend in housing prices due to the increase in money supply is expected to continue at least until March or April next year.

The increase in money supply was analyzed to have a significant production increase effect, mainly in manufacturing. When the money supply increases by 1.0%, GDP increases by up to 0.5% over three quarters. Jeong explained, "Assuming typical effects, economic policies responding to the COVID-19 shock can buffer the economic downturn by increasing production by about 1.0% with a lag of two to three quarters."

Jeong suggested, "Easing quarantine measures that restricted production activities in the service sector could ultimately act as a factor hindering economic recovery through the resurgence of COVID-19, so it is necessary to continue quarantine policies focused on health conditions rather than temporary economic stimulus." Considering that the production increase effect of macroeconomic policies takes a certain time lag, it is necessary to maintain the current expansionary stance for the time being, but if the pace of economic improvement falls short of expectations, efforts to buffer shocks to the economy through more expansionary macroeconomic policies will be required. Along with this, more emphasis should be placed on the fiscal role of income redistribution, such as supporting business adjustments in face-to-face and densely populated service sectors and continuing fiscal support to cushion employment shocks.

Jeong said, "Typically, macroeconomic policies that expand aggregate demand act as factors that temporarily raise prices in sectors like the housing market, where supply responds inelastically, but they also have effects that improve the real economy. This suggests the need to avoid policies that restrict supply expansion to resolve imbalances in specific sectors that may arise due to the expansion of money supply."

This content was produced with the assistance of AI translation services.