EDITORIAL from the Korea Herald on Dec. 5)

Deflation coming?

Prices are falling rapidly. Both designer dresses and casual apparel are being
sold in clearance sales. Cars can now be purchased at discount prices that have
been withheld until recently.

Housing prices have been slashed by up to 40
percent from their 2006 peak in the "bubble seven" areas previously prone to
property speculation, including Seoul's premium residential district south of the
Han River.

A cut in prices is not limited to clothing, automobiles and real estate. The
rapidly falling prices of oil and other commodities are pulling down the prices
of many other intermediate and final products. Inflation is no longer a concern
for the nation.
A continued decrease in general inflation should be a welcome development for not
only consumers but the Bank of Korea, one of whose primary missions is to
maintain moderate prices. Only a few months ago, the central bank was concerned
about the possibility of an increase in the consumer price index surpassing the
upper limit of its inflation target zone ranging from 2.5 percent to 3.5 percent.

But price increases falling below the level of zero percent inflation - or in
other words deflation - will do more harm than good to the nation's economy.
Deflation is quite different from disinflation - persistently low price increases
at a level slightly above zero percent inflation.
If deflation sets in, consumers will delay purchases and consumption until prices
decline further. This will in turn reduce overall economic activity, contributing
to a "deflationary spiral" - a vicious circle of falling prices leading to lower
production, which will cut wages and demand, which will again lead to a further
decrease in prices.
A solution to this economic problem is for the central bank and/or the
administration to stimulate aggregate demand. The central bank may lower its
benchmark interest rate to expand the money supply. The administration may borrow
and spend more on welfare and big-ticket public works projects.
Indeed, a boost in aggregate demand is what the United States and many other
countries in the world are aiming at by adopting aggressive monetary and fiscal
policies. In addition to spending astronomical amounts of money on bailing out
distressed financial institutions, the U.S. Federal Reserve is reportedly
preparing to cut its target rate on federal funds to zero percent. Central banks
in the European Union and other countries are also expected to make additional
rate cuts.
The Bank of Korea will have to take similar action when its Monetary Policy
Committee holds a monthly session next Thursday. The committee may well make a
drastic cut in one fell swoop, instead of making a series of small cuts - it has
often cut off 25 basis points at a time in the past.
Aggressive action is warranted by the worst economic conditions since the 1997-98
Asian financial crisis. The central bank can afford to make decisive and
preemptive action because its benchmark rate is significantly higher than those
in the United States and many other countries.
The Korean economy, which grew a mere 0.5 percent during the third quarter of
this year, will likely have contracted during the final quarter. Some renowned
financial institutions and economic think tanks predict the Korean economy will
shrink next year. Moreover, exports are now performing poorly.
At the same time, the central bank may well pump more liquidity into the market
by lowering the required reserve ratio for commercial banks and purchasing debt
instruments they have issued. It is also urged to heed advice from financial
experts that it will have to play a more active role in driving down market rates
by making available a larger amount of money than the initially envisioned 10
trillion won to stabilize the bond market.
(END)