[The Editors' Verdict] Let's Raise the Bank of Korea's Inflation Target to 3%

[Asia Economy Jeong Jaehyung, Economic Finance Editor] "Currently, U.S. inflation is higher than the target of 2%, undermining the credibility of the U.S. Federal Reserve (Fed). It seems better to raise the inflation target to 2.5% or 3%." (David Romer, UC Berkeley Professor)

"Since inflation is expected to approach 2% in the long term, there is no perceived need to adjust the inflation target." (Lisa Cook, Fed Board Member)

This discussion took place at the '2023 American Economic Association (AEA) Annual Meeting' held from the 6th to the 8th. Larry Summers, Harvard University Professor and former U.S. Treasury Secretary, said, "The era of high interest rates and high inflation may last longer," adding, "During the COVID-19 crisis response, fiscal spending surged in many countries, and with future increases in welfare and defense spending, high inflation will persist, pushing interest rates higher than previously expected."

In response to the 2008 global financial crisis and the 2010 European debt crisis, the U.S. and Europe implemented unprecedented quantitative easing policies (purchasing government bonds to supply money while maintaining near-zero base interest rates), which even led to negative interest rates. This unprecedented policy resulted in a prolonged era of ultra-low interest rates. However, following the COVID-19 pandemic's surge in fiscal spending and the Russia-Ukraine war, inflation soared, bringing the low-interest-rate era to an end.

Globalization, which accelerated with China's accession to the World Trade Organization (WTO) in 2000, has reached a turning point due to the U.S.-China hegemonic competition. The supply chains of advanced industries and resources/energy are being separated and reorganized. The era of globalization, which enabled global price stability, is coming to an end. De-globalization naturally leads to rising inflation.

In the book "The Great Demographic Reversal," co-authored by macroeconomics scholar Charles Goodhart and Manoj Pradhan, formerly of Morgan Stanley, and published in 2020, they warned that inflation would rise due to demographic changes and de-globalization. Along with aging populations in developed countries, China is also aging, leading to a decline in the working-age population. Workers tend to produce more than they consume, which is deflationary, but dependents consume without producing, which is inflationary. Automation, artificial intelligence, increased labor participation among the elderly, and population growth in India and Africa may offset rapid demographic changes but cannot stop the overall trend.

In South Korea, inflation rates below 2%, i.e., in the 0% or 1% range, were an unusual phenomenon from 2013 to 2020. This was due to economic recessions caused by the global financial crisis and European debt crisis, along with low interest rates and quantitative easing policies. The Bank of Korea's inflation stabilization target has been 2% since 2016. Before that, it was mostly 3% ± 0.5%, 3% ± 1%, or between 2.5% and 3%, all centered around 3%. That was considered normal.

Since an inflation target of 3% is normal, setting it lower at 2% may lead the Bank of Korea's base interest rate policy to be excessively tight. Trying to keep inflation too low could negatively impact economic growth. It would be difficult to expect a balanced interest rate policy between inflation and growth rates.

The American Economic Association is an academic organization, and the 3% inflation target has only been theoretically mentioned as a possibility. Central banks tend to be conservative, so it will take a long time before the Fed or the European Central Bank (ECB) consider this in actual policy.

The Bank of Korea decided at the end of December 2018 to maintain the inflation stabilization target at 2%. Previously, the inflation target was set every three years, but from then on, it decided to review and improve it every two years without a fixed application period. If unforeseen domestic or international economic shocks or changes in economic conditions make it inevitable to change the inflation target, it will be reset.

It seems advisable to soon begin discussions on resetting the inflation target.

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