[Opinion] There Is a Need to Increase Fiscal Spending to Stimulate Domestic Demand

Policy authorities have so far focused on curbing inflation. The Bank of Korea raised interest rates sharply, and the economic team stabilized the exchange rate to lower import prices. As a result, inflation, which had risen to 6.3% last July, recently dropped to 3.8%. However, the rapid interest rate hikes have deepened the economic recession. This year's growth rate is expected to fall to 1.4%, and industrial production, consumption, and investment all showed a decline compared to the previous month in October. The side effects of the high-interest-rate policy, namely the economic recession, cannot be overlooked.

First, there is a high likelihood that high interest rates will persist. Inflation can be demand-pull, where prices rise due to increased demand, or cost-push, caused by rising costs such as international oil prices, raw material prices, and wages. Demand-pull inflation can be effectively lowered by reducing demand through interest rate hikes, but cost-push inflation is difficult to reduce by interest rate hikes alone unless raw material prices fall. This inflation is cost-push, which is why sticky inflation is expected. If inflation does not easily decrease, high interest rates will continue, likely deepening the economic recession.

The increasing hardship of ordinary citizens and small business owners is also a problem, as it lowers support for economic policies. Recently, as the recession continues, bankruptcies among small business owners and self-employed individuals are rising. Ordinary citizens are also suffering from high interest rates, high prices, and the recession. The most important thing for ordinary people is the livelihood economy. To revive the livelihood economy, price stability is necessary, but economic growth and growth rates are more important. If low growth and recession persist and worsen, support for economic policies will decline, potentially weakening the momentum for the three major reforms?education, labor, and pensions?pursued by the current government.

The increase in financial insolvency and capital outflows is another reason to be cautious about the recession. If the recession continues, livelihood-related household loans will increase, and with rising interest burdens, the delinquency rate on household debt will rise, leading to more financial insolvency. Additionally, concerns about capital outflows will grow. Despite the interest rate gap with the U.S. widening to 2 percentage points, capital outflows have not occurred because the exchange rate and domestic financial markets remain stable. Especially in an economy with an open capital market, the economy is crucial. If the recession deepens, causing increased volatility in financial markets such as stocks and the collapse of asset price bubbles, anxiety about the country's economy will rise, leading to capital outflows and a sharp rise in the exchange rate.

From this perspective, the government needs to focus not only on price stability but also on economic recovery. Increasing exports is the best solution for economic recovery, but if exports are sluggish, domestic demand stimulation is necessary. Macroeconomic policy tools for stimulating domestic demand or the economy include interest rate, fiscal, and exchange rate policies, but currently, interest rate and exchange rate policies have limitations. Lowering interest rates to revive the economy could increase household debt and inflation, and raise concerns about capital outflows. Raising the exchange rate to increase exports could also raise import prices and increase capital outflows.

Ultimately, the only available policy tool is fiscal policy. The government needs to increase fiscal spending within the range that does not severely damage fiscal soundness to stimulate domestic demand. It is also necessary to build transportation, education, and distribution infrastructure in low-income residential areas. Reviving the construction industry can revive the domestic economy and alleviate wealth inequality. Additionally, micro-level measures such as lowering tax rates to increase consumption and improving the corporate investment environment to boost investment are needed.

There are various forecasts regarding the timing of U.S. interest rate cuts, but since this inflation is cost-push, it is unlikely that interest rates will be cut early in the first half of next year. The economic team needs to focus economic policy on economic recovery in preparation for prolonged high interest rates and a long-term recession.

Jungsik Kim, Professor Emeritus, Department of Economics, Yonsei University