Frankel, Harvard Professor: "Korea's Fiscal and Monetary Policy Normalization in Response to Global Interest Rate Hikes"

Ministry of Economy and Finance-KDI '2021 G20 Global Financial Stability Conference' Keynote Speech

"Budget Deficit and Excessively High Debt-to-GDP Ratio Should Not Overlap"
"Avoid Dollar-Denominated Debt and Limit Excessive Short-Term Borrowing to Manage Risks"

Professor Jeffrey Frankel of Harvard University, who delivered the keynote speech at the '2021 G20 Global Financial Stability Conference' held on the 7th by the Ministry of Economy and Finance and the Korea Development Institute (KDI). (Photo by Ministry of Economy and Finance)

[Sejong=Asia Economy Reporter Moon Chaeseok] Jeffrey Frankel, a professor at Harvard University in the United States, said on the 7th, "As the United States signals a tightening monetary policy, the world may raise interest rates, so South Korea should normalize its current expansionary fiscal and monetary policies."

Professor Frankel made these remarks at the '2021 G20 Global Financial Stability Conference' held in a hybrid format of in-person and video at the Lotte Hotel in Sogong-dong, Seoul, hosted by the Ministry of Economy and Finance and the Korea Development Institute (KDI) on the same day.

He explained that South Korea has a credit rating (AA- by Fitch) capable of bearing the large fiscal deficits aimed at stimulating the economy due to the COVID-19 crisis that has continued from last year through this year. He assessed that the expansionary fiscal policy implemented so far was appropriate.

However, since the U.S. Federal Reserve (Fed) has signaled that it will pursue a tightening monetary policy in the future, he viewed that continuing the current expansionary fiscal and monetary policies is not desirable.

Professor Frankel warned that although OECD countries have increased general government debt (D2) and have fiscal capacity to use for economic stimulus during crises, as seen in the high-growth periods of 2003?2007 and 2010?2013, caution is still necessary.

He said, "Budget deficits and the debt-to-GDP ratio should not overlap in the same period and the debt ratio should not be too high," adding, "This risk means that debt affects economic instability, as exemplified by a continuously rising debt-to-GDP ratio."

Professor Frankel explained that the Fed’s start of tapering (quantitative easing reduction) could signal the timing of interest rate hikes. He reminded that interest rate increases have triggered multiple debt crises over the past 40 years.

He advised, "Low- and middle-income countries face a much higher risk of 'sudden stops' caused by global investors’ asset withdrawals than advanced countries like the U.S. To become less vulnerable to external shocks, emerging countries should limit overall debt levels as much as possible, avoid dollar-denominated debt to prevent currency mismatches, and restrict excessive short-term borrowing."

A currency mismatch refers to a situation where debt denominated in foreign currency and assets calculated in the domestic currency differ. For example, if dollars are borrowed and converted into Korean won, and the won-dollar exchange rate rises (meaning the won depreciates), the debt amount in won terms increases accordingly. As of the closing price on the 7th, the won-dollar exchange rate was 1,156.5, up 6.62% (71.8 won) from the closing price of 1,084.7 on January 1. This means the won has depreciated by that amount.

Professor Frankel emphasized, "The higher the debt level, the greater the risk that external shocks like U.S. interest rate hikes will make the debt-to-GDP ratio unsustainable. Emerging countries can become less vulnerable to such external factors by resisting the temptation of dollar-denominated debt and short-term borrowing."

The conference was also attended by Lee Eok-won, 1st Vice Minister of the Ministry of Economy and Finance, Hong Jang-pyo, President of KDI, government and central bank officials from G20 member countries, and experts, who discussed ▲ the impact and response of macroeconomic risk factors in the COVID-19 era on international financial markets ▲ the impact of digital currencies on international financial markets and systems ▲ and the future and prospects of international financial markets and systems in the post-COVID era.

In his opening remarks, Vice Minister Lee diagnosed, "Although concerns about a sudden shift in U.S. monetary policy have somewhat eased, the potential negative spillover effects of capital outflows and increased volatility on emerging markets still remain."

President Hong said, "Advanced countries, where vaccines were quickly supplied and large-scale fiscal and financial support was possible, are recovering relatively fast, but emerging countries are recovering more slowly than expected. The recovery gap between advanced and emerging countries may act as a constraint on the global economic recovery."

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