"The Main Cause of Inflation is 'Excess Demand'... Total Supply Capacity Must Be Expanded"

Korea Economic Research Institute Presents 'Analysis of Inflation Factors' Impact and Policy Implications'
1% Increase in Excess Demand Raises Consumer Prices by 0.1%

[Asia Economy Reporter Han Ye-ju] There has been a claim that policies are needed to expand the economy's total supply capacity for price stabilization, while also inducing stability in wages and exchange rates.

The Korea Economic Research Institute (KERI) announced this on the 2nd in its report titled "Analysis of the Influence of Inflation Factors and Policy Implications."

KERI analyzed that the previously dominant inflation transmission path of "soaring international raw material prices → rising producer prices → rising consumer prices" shows signs of easing. In fact, the gap between producer and consumer prices was 4.9 percentage points in April, three months ago, but sharply decreased to 2.9 percentage points in July, just three months later. A KERI official stated, "The narrowing gap means that the previous increases in import prices and producer prices have begun to be reflected in consumer prices, which implies that the additional upward pressure on consumer prices will be alleviated accordingly," and predicted, "Consumer prices will peak in September and then slow down."

However, due to excess liquidity and high wage increases during the COVID-19 response, inflation expectations, and global supply chain disruptions, high inflation rates of 5-6% are expected to persist for the time being.

KERI analyzed quarterly data from the first quarter of 2005 to the first quarter of 2022 to assess the magnitude of the impact of excess demand (GDP gap), unit labor costs, and import prices on inflation.

The analysis showed that the order of influence on inflation is ▲excess demand (GDP gap) ▲unit labor costs ▲import prices in Korean won. Consumer prices were found to rise by 0.1% when excess demand increases by 1%, and by 0.04% when unit labor costs increase by 1%. Additionally, consumer prices rose by 0.02% when import prices in Korean won increased by 1%. Based on the analysis, KERI interpreted that the impact of excess demand on consumer prices is very large, being 2.5 times that of labor costs and 5 times that of import prices.

Accordingly, KERI viewed that since excess demand is the biggest factor causing inflation, the most efficient measure is to expand the economy's total supply capacity by enhancing economic vitality through deregulation and tax burden reduction. However, since expanding supply capacity is a mid- to long-term task, it is necessary in the short term to stabilize wages by calming inflation expectations and stabilize import prices through exchange rate stability efforts such as maintaining a trade surplus.

Choo Kwang-ho, Director of Economic Policy at KERI, pointed out, "Since the Korean economy depends mostly on imports for major international raw materials, it is constantly exposed to inflation threats," and added, "Strengthening economic fundamentals and growth potential is the optimal solution to minimize price pressures, so efforts should focus on enhancing corporate vitality through regulatory reform, tax cuts, and improving labor flexibility."

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