Japan’s failures should be lesson for policymakers

The specter of deflation is haunting the nation amid the global economic downturn. Deflation, which is feared to be caused by mounting debt, is unprecedented here and experts warn that Korea may be trapped in a long tunnel of recession like Japan unless due policy measures are taken in a preemptive way.

When the central Bank of Korea reported a 1.5 percent rise in August consumer prices earlier this month, the market’s reaction was quite unexpected. Most market watchers expected that the 1.5 percent rise would be welcomed as signs of price stability but rather, it was seen as an indication that the Korean economy may be slipping into deflation.

It’s embarrassing to both the public as well as policymakers who have become familiar with warnings against inflation for decades. In fact, external economic conditions are serious enough to worry about deflation, which usually refers to a decrease in the general price level of goods and services.

Since the 2008 Lehman Brothers meltdown, the Korean economy has grown in the anemic 3-percent range, which is below the country’s potential growth rates. And the outlook for the foreseeable future is not that bright. Stung by the global business slump and deepening economic uncertainties, exports have dwindled rapidly and domestic demand remains in the doldrums.

The Korea Economic Research Institute (KERI) revised down its growth forecast for Korea in 2012 to 2.6 percent from its earlier forecast of 3.2 percent, citing the lingering debt crisis in Europe and a slowdown in the U.S. and China.

The salient feature of the latest concern on deflation is that debt, particularly loans lent to households, may pull the trigger for deflation, which is far more painful than inflation in general, as is seen in the case of Japan.

Banks’ rates for fresh loans averaged 5.7 percent in the first half of this year, down 1.47 percentage points from 7.17 percent in 2008. However, debt obligations by both households and businesses have not diminished as effective interest rates, which are measured by nominal rates minus inflation, surged.

The average effective lending rate rose to 3.3 percent in the first half of this year, the highest since 3.79 percent in 2007 and nearly double the 1.76 percent of last year. Although nominal rates declined, inflation rates dipped by a wider margin, which sparked signs of typical debt deflation ― borrowers’ real debt-service burden expands and asset prices dip.

True, most economists still discount the possibility that Korea will grapple with deflation. Yet, given that Japan’s ``lost decade’’ was caused by the bursting of asset price bubbles, Korea can’t afford complacency.

In this regard, Japan’s failures should be a valuable lesson for Korean policymakers. Japan lost opportunities to dispose of insolvencies caused by real estate from the outset of the bubble bursting.

What is needed now is that the government should look at the situation seriously enough and come up with preemptive measures to ensure that real estate price falls won’t lead to insolvencies in household debt.