[Insight & Opinion] New Year's Economic Policy Should Focus on Reviving the Livelihood Economy

As New Year inflation is expected to drop to the 2% range, forecasts for interest rate cuts and economic recovery are emerging one after another. There is an optimistic outlook that the U.S. Federal Reserve will cut the policy rate by up to 0.75 percentage points within the year starting from March, and a significant rise in stock prices is also anticipated. However, although the inflation rate may decrease to the 2% range allowing for interest rate cuts, the economic situation of high inflation, high interest rates, and low growth is likely to persist. This is because while the inflation rate decreases, the elevated price levels will not fall. In fact, prices tend to exhibit a so-called ratchet effect, where raw material prices rise and prices increase, but when prices fall, they do not decrease and remain frozen.

The possibility of wage increases is also a background factor for high inflation. Workers whose real incomes have decreased due to rising living costs are likely to demand wage increases with a time lag. The economy could enter a vicious cycle of wage hikes and inflation. Additionally, unstable Middle East situations and the global trend of interest rate cuts could drive up international crude oil prices. Considering this, it will not be easy to return to low inflation as in the past, and high inflation is likely to become the new normal.

The low growth phase is also expected to continue. Real incomes decrease due to high inflation, making it difficult for consumption and investment, i.e., domestic demand, to increase. Furthermore, the U.S. is likely to strengthen protectionism to reduce the trade deficit that has increased due to the strong dollar. The U.S.-China conflict and the slowdown in China's growth rate could reduce our exports and lower growth rates, while the narrowing technological gap with China weakens export competitiveness, which also supports the outlook for low growth. This is evident from last year's trade deficit with China, which was the first since the establishment of diplomatic relations between Korea and China in 1992.

Moreover, the scale of U.S. interest rate cuts may not be large. The causes of inflation differ between the U.S. and Korea. In Korea, the main causes of inflation are crude oil, raw material prices, and exchange rate increases, whereas in the U.S., wage increases are the primary factor. Inflation in Korea can decrease if crude oil prices and exchange rates fall, but in the U.S., inflation can only slow down if wages in the labor market decrease. This is also reflected in the fact that the U.S. core inflation, excluding seasonal factors such as crude oil and agricultural products, remains high at around 4%. If the U.S. interest rate cuts are small, it will be difficult for Korea to implement large-scale rate cuts, making it hard to escape low growth.

The continuation of high inflation and low growth causes great pain for both companies and citizens. Small business closures are already increasing, and ordinary people are also experiencing significant difficulties in their daily lives. This pain will intensify as the low growth phase continues. To restore the livelihood economy, policymakers must stabilize prices and revive the economy. However, these two goals conflict with each other. To stabilize prices, one must endure an economic downturn caused by high interest rates, and to stimulate the economy, prices must be sacrificed. In fact, last year, despite a significant interest rate hike that lowered inflation to the 3% range, the growth rate dropped sharply to the low 1% range, deepening the economic recession.

Policy choices are made by weighing benefits and costs. At the beginning of the current administration, the cost of inflation was high, so the focus was on price stabilization, but in the new year, with persistent low growth, the cost of economic recession is greater. Although real estate PF (project financing) defaults are currently a problem, if the recession continues, household debt and corporate insolvency are expected to increase. Additionally, as the pain of the livelihood economy grows due to low growth, public support for economic policies is also declining. The new economic team must focus the new year's economic policy on economic recovery and go all-in to revive the livelihood economy.

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