After 2008, a 2 percent target, and an April 2016 reading

After the 2008 global financial crisis, the notes write, inflation in major economies such as the United States, Europe, and Japan stayed on a downward path, and there was concern that the world economy might slip into deflation. They cite a recent announcement, in their telling, by the European Central Bank: a flash estimate of inflation for April 2016 of −0.2 percent, which raised a fear that the euro-area economy might be falling into deflation. Deflation, they write, is the opposite of inflation, and means a persistent fall in prices. Both inflation and deflation harm an economy, but the destructive power of deflation is stronger, and a response is harder to prepare.

After the crisis, they write, central banks tried to push inflation up toward a target of around 2 percent, and one method was to cut the policy rate, or benchmark rate. Once rates had come close to the 0 percent range, some also turned to an unconventional monetary policy: the central bank would buy government bonds already held by private banks, and inject money directly into the economy. A then-current debate in Korea about quantitative easing, they add, can be seen as part of that unconventional policy; it also brought problems, including a possible wound to a central bank’s independence and an unclear effectiveness, and needed, they write, to be examined with care. Those figures and debates belong to the years the notes name.

What inflation and deflation each do, and a warning from 2014

Inflation, or a rise in prices, means a persistent rise in the general level of prices for goods and services. When it occurs, the value of money falls and purchasing power weakens, while the value of real assets rises. A negative effect they name is that the opportunity cost of saving money increases; if people expect prices to rise in the future, the will to save can fall. A rise in interest rates to fight inflation can, by contrast, make the cost of an existing loan relatively lighter for the borrower. Among the positive effects, they write, inflation can lower the real value of debt, encourage investment in real assets, and, when wages rise faster than prices, give producers a motive.

Deflation, they write, can mean a negative rate of price change, at or below 0 percent, but in practice it also means a fall below a certain level, or below the floor of an inflation-target range. In August 2014, they record, Choi Kyung-hwan, then deputy prime minister for the economy, said that Korea’s inflation-target range was 2.5 to 3.5 percent, that prices had been heading toward the floor for three years, and that he was concerned the economy was in the early stage of deflation. In a period of deflation, they write, firms sell goods and still make little profit, so profits, investment, and employment all fall; cash becomes more valuable relative to goods and services, and the real cost of interest, the price of using that cash, also rises. Supply-side deflation — when demand is unchanged, but supply rises through higher productivity or an innovation in the production process, and prices fall — can, they add, actually be a good case. The harms they list arise when demand-side deflation sets in: consumption and investment shrink, prices and the cycle fall together, and people put off spending further. If debt is already large, the risk of default rises, financial institutions weaken, credit tightens, and policy itself can be constrained; in an extreme case, they write, monetary policy can lose its force in a liquidity trap, especially if private banks do not release the proceeds of the bonds they have sold to the central bank, or if they invest them abroad.

A Bank of Korea view in April 2016, and a glance at Japan

Some, the notes write, were already raising the possibility of deflation in the Korean economy, given a long slump and falling inflation. In April 2016, however, the Bank of Korea, on the basis of its monetary and credit policy report, said that a deflation-vulnerability index had recorded 0.09 in each of the third and fourth quarters of the previous year, a level corresponding, in their wording, to a possibility that was “extremely low.” Consumer prices had, since the second half of 2014, kept a low rise of around 1 percent, but core-inflation indicators, which show the underlying movement of prices, were, the Bank said, stable at a level above the rise in consumer prices. The low consumer-price figure was due in large part to a supply shock such as cheap oil, and the Bank expected the rise in consumer prices, already widening in the second half of that year, to move gradually toward the inflation-target level. In sum, the Bank judged the risk of deflation to be very limited, even if low prices had lasted a long time. The writer still saw, in the same notes, many uncertainties that could yet bring deflation.

Before turning to remedies, they glance at Japan’s long slump, often called the “lost twenty years.” Korea, they write, had likewise seen weak domestic demand settle in as a structural fact, and an export-led growth structure that left it very exposed to changes abroad. What they call still more serious is a very rapid fall in the birth rate and a rapid aging of the population, shrinking the working-age population. Social support for childbirth and child-rearing was, in their account, still thin; women’s labor supply was low compared with other advanced countries — among 34 OECD members, they give Korea’s female employment rate as 54.9 percent, far below a 61.1 percent average, and 27th of the 34 — and the retirement of the baby-boom generation added to the worry. As labor supply fell, the capital-to-output ratio was rising, as in Japan, returns on investment were falling, the marginal product of capital was dropping, and capital was flowing out. Those comparisons, and the official figures they cite, remain in the notes’ own years, not as later official totals. The same Korean report, at fuller length, is on CampusDown.

Sources

1. The notes’ account of deflation fears after 2008, including the ECB’s April 2016 flash estimate and the Bank of Korea’s April 2016 reading

Last updated: 14 November 2026