Peterson Institute Director: "US High Interest Rates Until 2025... South Korea Must Increase Immigration and Female Participation" [Issue Interview]

Interview with Adam Posen, Director of Peterson Institute for International Economics
"Not a De-globalization Issue but a Decline in the Quality of Globalization"
"South Korea's Household Debt Should Be Addressed with Loan Regulations, Not Interest Rates"
"Chinese Communist Party's Private Sector Intervention Acts as Downward Pressure on Economy"

"The United States is likely to lower its benchmark interest rate only in 2025."

Adam Posen, President of the Peterson Institute for International Economics (PIIE), said this in an interview with Asia Economy on the 3rd regarding the future direction of the U.S. Federal Reserve's monetary policy. He analyzed that since the real interest rate in the U.S. is not yet at a very high level and the U.S. economy is expected to remain robust next year, high interest rates will be maintained until the second quarter of 2025.

Posen stated, "The U.S. economy will not enter a recession but will rather show positive growth," adding, "Even if rates are cut after 2025, the U.S. government's fiscal spending is so large that the rate cuts will not be significant." In particular, he predicted that "the U.S. neutral interest rate has likely risen by about 75 to 100 basis points (1bp = 0.01 percentage points) compared to pre-COVID-19 levels," and over time, the 10-year U.S. Treasury yield could reflect changes in the neutral rate.

Posen foresees that aging populations and declining demographics in advanced countries may weaken consumption and exert downward pressure on prices, but massive fiscal spending by advanced country governments will instead push prices upward. He emphasized, "Many high-income democratic countries will spend heavily on public sectors such as defense and welfare," adding, "If taxes are raised proportionally to fiscal spending, there is no problem, but if not, inflation will occur."

Accordingly, Posen added that due to prolonged high inflation and high interest rates, the central banks' inflation target, currently at 2%, should be raised to 3%.

Regarding the Korean economy, he asserted, "The era of high growth is over," and said Korea must actively accept foreign immigrants. He explained, "It is realistically difficult for Korea to achieve the same level of high growth as before," and "Even if the average GDP growth rate is raised, it should be seen as about 0.5 to 1 percentage point." He also pointed out that "Korea should utilize methods such as increasing the participation of educated women in the labor market or bringing in foreign workers," emphasizing that Korea does not need to be a 'sexist or racist' country.

Posen is a world-renowned economic scholar who has led the Peterson Institute for International Economics, a prominent U.S. think tank, since 2013. He graduated from Harvard University and has served as an economist at the Federal Reserve Bank of New York and as a monetary policy committee member at the Bank of England. Invited by Lee Chang-yong, Governor of the Bank of Korea, he visited Korea and held a meeting with Bank of Korea staff on the 3rd before giving an interview to Asia Economy.

Below is a Q&A with Adam Posen.

"No U.S. Recession... High Interest Rates Continue Until 2025"

-There are forecasts that the U.S. economy will enter a recession from the second quarter of next year and that the benchmark interest rate will be lowered. How do you evaluate this?

▲I do not agree that the U.S. economy will enter a recession. One year from now, the U.S. economy is likely to show positive growth. Accordingly, I believe the Federal Reserve's benchmark interest rate will maintain the current level of 5.25?5.50%. The U.S. is likely to lower the benchmark rate only after the second quarter of 2025. Until then, high interest rates will continue. Even if rates are cut, the U.S. government's fiscal spending is so large that rates will not be lowered significantly.

-The U.S. labor market and economy remain hot even after the pandemic. What is the reason for this?

▲In the past, the U.S. economy usually entered a recession for one of two reasons: either the Fed raised rates sharply at once, or there was a problem in a part of the financial sector. Although the Fed has recently raised the benchmark rate significantly, when converted to real interest rates, it is not as high as it seems. Also, looking at the balance sheets of households and non-financial corporations, debt is not high, and residential real estate has not fallen significantly. On the other hand, fiscal spending has been enormous, stimulating the economy. Data from the past six months show productivity has improved. However, it is still unclear whether this productivity increase is temporary or a real rise.

-How much do you think the U.S. neutral interest rate has risen?

▲The neutral interest rate is an economic phenomenon. If high-income countries continue to implement expansive fiscal policies, increasing the government deficit-to-GDP ratio, this will be an upward factor for the neutral rate. The recent rise in the U.S. 10-year Treasury yield may reflect the increase in the neutral rate. Although the neutral rate is not the same as the 10-year Treasury yield, over time, the 10-year yield will reflect changes in the neutral rate. The neutral rate has probably risen by about 75 to 100 basis points compared to pre-COVID-19 levels.

-If high interest rates persist for a long time, do you think central banks should raise their inflation targets (currently 2% annually)?

▲I have supported raising the inflation target over the past decade. Naturally, I still think so. Previously, I argued for raising it to 4%, but considering the current low confidence in U.S. inflation, 3% seems appropriate.

-Recently, the U.S. fiscal deficit has increased significantly, causing government bond yields to rise. Although the dollar is the global reserve currency, how long can the U.S. government sustain its fiscal deficit?

▲To stop the U.S. fiscal deficit, there must be an alternative to the dollar as a reserve currency. Although the dollar has been weakening recently, competing currencies (euro, yuan, etc.) are even weaker. Most countries do not want to increase their exposure to the Chinese government. Europe is suffering due to the Russia-Ukraine war. There is no other alternative. If there is a risk, it is a rise in global interest rates, not a de-dollarization risk.

"Expansion of Fiscal Spending... Inflation Occurs If Taxes Are Not Raised"

-Population aging and deglobalization in major countries can be factors causing inflation. Will an era of high inflation like the past return?

▲Average inflation is likely to remain higher at around 3% for the next few years. However, aging itself does not cause inflation. Population aging in Korea and Japan exerts downward pressure on prices because average age increases reduce consumption. Japan experienced this in the 1990s and 2000s.

-According to Charles Goodhart's 'Population Reversal,' the working-age population (15?64 years) produces more than it consumes, causing deflationary pressure, while elderly dependents consume without producing, causing inflationary pressure. Does this mean that more elderly people can cause inflation?

▲I am well aware of his theory, but it has been refuted by data from the past 20 years. In all high-income countries, the share of labor in the economy is declining. Also, high-income countries like Korea and the UK can allow immigration at any time. This distorts labor supply, so the theory that inflation will occur due to fewer workers and more elderly is incorrect.

-How might recent deglobalization and supply chain separation affect inflation?

▲They can cause short-term inflation shocks. For example, moving factories from China to Mexico may cause inflation once. But this is temporary and does not raise the long-term average inflation rate. A more accurate term than deglobalization is a decline in the 'quality of globalization.' Even after the U.S.-China trade dispute, global trade volume continued to increase. However, holes have appeared in global supply chains, and their quality has declined. This affects the real economy more than prices. It reduces innovation competition and increases uncertainty.

-Then, is the current high inflation rate unusual? Will we no longer need to worry about inflation in the future?

▲No. Many high-income democratic countries will spend heavily on the public sector, such as defense, green economy transition, and welfare for the elderly. Such fiscal spending will eventually cause inflation. If taxes are raised proportionally to fiscal spending, there is no problem, but if not, inflation will occur.

"Korea Can No Longer Achieve High Growth... Must Accept Foreign Workers"

-What do you think about the future of the Korean economy?

▲Korea cannot continue to grow in the way it has so far. Growth rates will continue to decline. Realistically, high growth like before is difficult. Despite aging, Korea has done very well in recent years. Korea can raise its average GDP growth rate, but realistically, even if it does, it should be about 0.5 to 1 percentage point.

-What structural reforms are needed for Korea to return to high growth?

▲Korea must accept immigrants and increase female labor force participation. In 2021, I told Korean public officials the same thing I told Japan 20 years ago: "You can be sexist or racist, but you cannot be both." To put it gently, to effectively increase labor supply, Korea should either increase the participation of educated women in the labor market or bring in foreign workers. Korea should do both. I recommend that. Additionally, joining the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP) and increasing trade openness will also help growth.

-Korea is participating in the U.S.-led Indo-Pacific Economic Framework (IPEF). Considering relations with China, how should Korea approach this?

▲President Joe Biden hopes IPEF will become a network to counter China. But IPEF itself has little practical significance. The only element that might anger China is 'friend-shoring,' which means relocating factories or production bases from China to allied countries. Korea can always say, 'We did it because the U.S. asked us to.' So, I am not very worried.

-Korea has one of the highest household debt-to-GDP ratios in the world. This burdens monetary policy and growth. Should the benchmark interest rate be raised to reduce household debt?

▲I know Governor Lee Chang-yong and the Bank of Korea have warned about household debt, and I think it is at a concerning level now. However, looking at past crises like the 1990s Asian financial crisis and the 2008 global financial crisis, regulations are more effective than benchmark interest rates. The Chinese Communist Party also tried to address the real estate bubble with monetary policy but had little effect; recently, they started using regulations, and the bubble quickly deflated. In Korea, stricter loan eligibility for individuals and bank lending regulations are needed. This is more effective than raising benchmark interest rates to reduce household debt.

"China's Biggest Problem Is Communist Party Intervention"

-China's growth is slowing due to the real estate downturn and U.S. supply chain separation policies. What do you expect going forward?

▲I think China's real estate downturn is a temporary problem. Also, U.S. supply chain separation will not have a major impact. The biggest problem is the Chinese Communist Party's economic intervention. Since 2015, the Party has emphasized the government's role and made various incomprehensible interventions. Especially through the zero-COVID policy, most Chinese citizens felt threats to their jobs and assets. Because of this, even after the zero-COVID policy ended, China did not significantly increase consumption like Korea or Japan. Instead, people hoarded cash. This will exert downward pressure on China's economy for the next few years. The fear felt by Chinese citizens leads to low economic growth.

-The U.S. is blocking China in advanced technology fields such as semiconductors and artificial intelligence (AI). Can China overcome this on its own?

▲I think it will be difficult. In the long term, Chinese companies will struggle to develop all the necessary technologies independently.

-China has played the role of 'the world's factory' in manufacturing. Can it continue to do so?

▲Even before the U.S.-China dispute, as wages and incomes rose in China, industries at the lower end of the value chain were relocating to other countries. This process has accelerated over the past two to three years. Countries like Indonesia and Mexico are receiving more of these lower-end industries.

-Recently, the Japanese economy has revived. Is this due to Japan's quantitative easing (central bank directly supplying money to stimulate the economy) and zero interest rate policy?

▲I think it is due to other reasons. I supported Japan's quantitative easing, but it was insufficient. If it had been enough, Japan's economic growth rate would have risen faster. Japan's economic growth is due to structural reforms implemented by former Prime Minister Shinzo Abe, including joining the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP), increasing female labor participation, and corporate governance reforms.

-Germany is struggling due to its export-oriented structure and deglobalization after COVID-19. Moreover, with the inability to use Russian oil and natural gas, there are talks of a German economic crisis and Germany becoming 'the sick man of Europe' again. What is your view?

▲I know this is a very popular perception, but data show the opposite. A year and a half ago, many predicted that if Russian energy and trade disappeared, the German economy would suffer greatly. However, looking at the current German economy, it is not yet in recession. The most recent German GDP statistics were revised upward. It is remarkable how quickly German households and companies have adapted to rising energy prices and reduced energy supply.

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