[Insight & Opinion] If Economic Recession Is Unavoidable, We Must Prepare

[Asia Economy] At the American Economic Association meeting held on the 6th in New Orleans, Louisiana, many prominent economists warned of a prolonged economic recession in the United States and the global economy. This is because the current high interest rate trend is expected to continue for a considerable period due to cost-push inflation caused by liquidity released during COVID-19, rising wages, and raw material prices. Harvard professors Lawrence Summers and Kenneth Rogoff also predict that the global economy cannot return to the pre-COVID-19 era of low interest rates and low inflation, and that a deepened recession under high interest rates and high inflation will persist for a significant time. In reality, it is difficult to stabilize cost-push inflation caused by wage increases and rising raw material prices through interest rate hikes. To stabilize cost-push inflation driven by increased costs by reducing demand, a very large interest rate hike is necessary, which would lead to a severe recession.

The Bank of Korea raised interest rates sharply last year in response to concerns about capital outflows and a sharp rise in the exchange rate caused by U.S. interest rate hikes. While these high interest rates can somewhat reduce inflation and stabilize the foreign exchange market, the problem is that the financial market may become unstable due to recession and the collapse of the real estate bubble. If the main policy task of the authorities last year was to stabilize the exchange rate and prices in response to external shocks, this year’s policy task, as many scholars warned at the American Economic Association meeting, should focus on avoiding a domestic recession and stabilizing the resulting domestic financial market instability. This is because the effects of interest rate hikes appear with a time lag in prices, the economy, and real estate prices. The sharp interest rate hikes last year are likely to deepen this year’s recession, worsening funding difficulties for companies and households and increasing the possibility of a real estate bubble collapse.

First, the real estate market must be smoothly adjusted to prevent the construction industry, which is most closely related to the domestic economy, from becoming excessively depressed. The government has recently eased various real estate regulations implemented during the low interest rate era to suit the high interest rate era and is normalizing tax policies. However, to prevent the collapse of the real estate bubble, it is necessary to lower excessively high loan interest rates. Financial institutions, which determine loan interest rates under supply monopolies, have excessively raised loan interest rates so far. This is evident from the fact that although the Bank of Korea raised the base rate by 2.25 percentage points last year, the mortgage loan interest rates from financial institutions rose to over 8% at the highest. Recently, when financial authorities expressed concerns about excessively high deposit interest rates, loan interest rates were lowered by 0.9 percentage points. However, policy authorities should apply low policy interest rates to loans for low-income households or jeonse (long-term deposit) loans, as in the previous administration, to smoothly adjust the real estate bubble and prevent excessive domestic economic recession.

It is also necessary to increase support for export companies and manage the won-yen exchange rate to prevent it from falling too low. Due to the global recession, there are concerns that our exports will decrease further this year. Increasing exports not only helps avoid recession but also raises external credibility through a current account surplus, preventing capital outflows despite interest rate differences with the U.S. Policy authorities need to actively increase tax and financial support for export companies to enhance export competitiveness. Additionally, managing our exchange rate considering the depreciation of the Japanese yen is important. Currently, the won-yen exchange rate has fallen to 940 won per 100 yen. In the past, when the won-yen exchange rate fell excessively, our export competitiveness declined, and the current account balance worsened in many cases.

This year, both the global and Korean economies are likely to face increased financial market instability due to high interest rates and prolonged recession. For our economy to avoid recession, corporate and household insolvency, and stabilize the financial market, proactive and correct policy choices by the authorities are more important than ever.

Kim Jeongsik (Emeritus Professor, Department of Economics, Yonsei University)