By Yoon Ja-young
A government-run think tank says the central bank should cut its key interest rate, citing the risk of falling into deflation, as happened in Japan.
Korea Development Institute (KDI) Director Lee Jae-joon said at a seminar on Tuesday that concern over deflation was growing in Korea amid continuing sluggish demand and low inflation.
Inflation has remained at around 1 percent, short of the central bank’s 2.5-3.5 percent target.
Lee said Korea had lessons to learn from Japan’s “lost decade.”
“Japan ended up in deflation because it failed to implement appropriate policies after the collapse of the bubble in the early 1990s,” he said. “It is a lesson with regard to monetary policy.”
Following the bubble in late 1980s, the Japanese economy fell into recession with the collapse of the real estate market and stock market in 1990.
As the recession extended beyond the general economic cycle, deflation set in from the mid-1990s, according to Lee.
He said sluggish demand had basically triggered Japan’s deflation.
“Due to the failure in demand policy, it lost opportunities for recovery,” he said. He added that the Bank of Japan had failed to recognize the possibility and risks of deflation.
“The Japanese policymakers focused on the supply…overlooking the seriousness of the deflation,” he said.
He pointed out that the GDP deflator growth in Korea has been far below the consumer price index (CPI) rise since 2011. While the CPI measures only the price of consumer goods, the GDP deflator measures all production prices. The fall in the GDP deflator can lead to a shrinking economy as well as slowdown in CPI growth, Lee said.
He said that while Japan cut the nominal interest rate a few times to cope with the recession, the fall in inflation offset the effect.
“The recent continual low inflation may be offsetting the effect of the key rate cut in Korea,” he said, adding that Korea needed a policy of quick monetary easing to cope with the deflation risk.
Korea’s key rate stands at a historically low 2 percent, following a series of cuts.
Lee said he was concerned that people might be taking low inflation for granted.
“The monetary policymakers should know that a key rate policy that overlooks falling expectations on inflation can increase the deflation risk even further,” he said.