[The Editors' Verdict] The Intensifying Debate Over Inflation

Kim Kyung-soo, Professor Emeritus at Sungkyunkwan University

There is a fierce backlash surrounding the GameStop 'short squeeze' (buying stocks to cover short positions or reduce losses). One of the key issues is the monetary policy of the U.S. Federal Reserve (Fed), the epicenter of the global financial cycle. Last week, Gillian Tett, a columnist for the UK Financial Times (FT), criticized the Fed's forward guidance, which maintains existing policies until inflation exceeds the 2% target for some time. She argued that at a time when inflation needs to be reined in in response to the Biden administration's $1.9 trillion stimulus package, the Fed is repeatedly sending the message, "Don't worry about inflation. You can borrow money for free for several years." This is a warning that the Fed's message is fostering bubbles and debt, which will ultimately lead to greater problems.

Initially, the argument that low interest rates lowered the required returns on risky assets like stocks, thereby increasing their fundamental value, gained traction. However, as market interest rates rise, the bubble theory is gaining strength. The cyclically adjusted price-to-earnings (CAPE) ratio developed by Robert Shiller, a Nobel laureate and professor at Yale University, is the highest except for the dot-com bubble period.

Debt and inflation are currently the biggest issues in the global economy. According to the Bank for International Settlements (BIS), in the second quarter of last year, the debt of the non-financial private and government sectors relative to GDP in emerging markets (209.8%) nearly doubled compared to before the global financial crisis, and in advanced economies (300.9%) it increased by 20%. South Korea (252%) also saw an increase of over 25%. Inflation is now spreading from real estate and stock markets to international commodity markets such as crude oil. Although current inflation is low, this is evidence that future inflation is expected to be high.

Typically, expected inflation is estimated by subtracting the yield on inflation-linked bonds (which adjust principal and interest payments for inflation to control inflation risk) from the yield on government bonds. According to this estimate, expected inflation has already exceeded pre-pandemic levels since the fourth quarter of last year. Despite zero interest rates, the rise in U.S. Treasury yields is due to increasing expected inflation.

The rising inflationary pressures are not only due to demand-side factors such as unprecedented expansionary monetary and fiscal policies but also supply-side factors. Despite increased international trade volumes, a shortage of shipping capacity has caused a sharp rise in maritime freight rates, and a shortage of automotive semiconductors has severely disrupted global automobile production. The trend of rising producer prices in many countries since the fourth quarter of 2020 also suggests supply-side factors.

Recently, former U.S. Treasury Secretary Lawrence Summers and former IMF Chief Economist Olivier Blanchard warned about inflation resulting from the Democratic administration's massive stimulus measures. The uncertainty caused by inflation higher than the Fed initially expected is a concern. It is difficult to predict how money will move if inflation rises in a core country within the global financial ecosystem built on low inflation in the 21st century. Domestic research institutions, including government-funded think tanks, have also warned about the side effects of low interest rate policies that have caused asset inflation. The Bank of Korea's low interest rate policy has been said to have caused asset inflation such as housing prices rather than promoting investment and consumption.

The velocity of circulation, calculated by dividing nominal GDP by broad money supply (M2), has fallen to an all-time low in both South Korea and the U.S. but is now showing signs of reversal. This is interpreted as the vast amount of money released so far moving from asset markets to the real economy. Clearly, inflation is a topic of debate this year.

Kyungsoo Kim, Professor Emeritus, Sungkyunkwan University

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