🚨 The Double Burden of Low Growth and High Inflation, Stagflation Risk Analysis
Today Korean Economic News | 2025.03.01
📌 1% Low Growth Shock, High Exchange Rate Leads to High Inflation... 'The Fear of S' Returns
💬 Despite the Bank of Korea's decision to lower the base rate, inflation continues to rise, increasing concerns about stagflation (inflation amid economic recession). The Korean economy is likely to continue its low growth phase of less than 2% for the fourth consecutive year, with the Korean won's depreciation and rising oil prices continuously putting pressure on consumer prices.
1️⃣ Easy Understanding
The Korean economy is in a difficult situation. Economic growth is slowing down, but prices are rising. In economics, this situation is called 'stagflation,' which is very difficult to address with policy. I'll explain why this situation has occurred and how it affects our lives in simple terms.
Stagflation is a phenomenon where 'economic stagnation' and 'inflation' occur simultaneously. Normally, when the economy slows down, demand decreases, and prices stabilize or fall, but in a stagflation situation, the contradictory situation occurs where prices continue to rise despite a poor economy.
Currently, the Korean economy's growth rate remains in the 1% range, and this is the fourth consecutive year of low growth below 2%. This low growth restricts corporate investment and employment, and limits household income growth. According to recently released employment indicators, quality jobs are decreasing, and employment conditions in manufacturing and construction are deteriorating.
Meanwhile, inflation is showing a higher than expected upward trend. The consumer price inflation rate is 2.2%, exceeding the Bank of Korea's target of 2.0%, with particularly noticeable increases in the prices of daily necessities and services. The main causes of this inflation are the depreciation of the Korean won (rising exchange rates) and international oil price increases. As the KRW/USD exchange rate exceeds 1,350 won, import prices have generally risen, and rising international oil prices are acting as overall inflation pressure by increasing energy costs and logistics expenses.
To explain this situation with an everyday example, it's similar to a family's income not increasing or even decreasing, while living costs like grocery shopping, dining out, and utility bills continue to increase. This results in a decline in the actual standard of living.
The Bank of Korea recently cut the base interest rate from 3.00% to 2.75% to respond to this situation. This is a measure to address the economic downturn, but there are concerns that the interest rate cut could stimulate inflation. Moreover, as the United States is taking a cautious attitude toward interest rate cuts, if only Korea lowers its rates, the value of the Korean won may fall further.
Ultimately, stagflation forces policy authorities to make difficult choices between 'growth and price stability.' Lowering interest rates to stimulate the economy could worsen inflation, and implementing tight policies for price stability could deepen the economic downturn. If this situation persists, both households and businesses are likely to experience the double burden of reduced real income and deteriorating business conditions.
2️⃣ Economic Terms
📕 Stagflation
Stagflation is an economic phenomenon where economic stagnation and inflation occur simultaneously.
- In normal economic cycles, prices tend to stabilize or fall during recessions, but stagflation is a special situation that deviates from this pattern.
- The world economy experienced this during the oil crisis of the 1970s, with supply-side shocks often being a major cause.
📕 Low Growth
Low growth is a state where the economy shows growth below its potential growth rate, negatively affecting employment and income.
- Korea's potential growth rate is estimated at about 2.0-2.5%, and growth rates in the 1% range below this are considered low growth.
- It occurs due to a combination of structural factors (population decline, productivity stagnation, etc.) and cyclical factors (deteriorating external environment, sluggish domestic demand, etc.).
📕 High Exchange Rate
High exchange rate occurs when the value of domestic currency falls against other currencies, becoming a factor in import price increases.
- When the KRW/USD exchange rate rises, more won is needed to purchase imported goods at the same dollar price.
- While there is a positive aspect of improved export competitiveness, it can act as inflationary pressure for the Korean economy, which has high dependence on imported raw materials.
📕 Base Rate
The base rate is the policy rate set by the central bank that serves as the standard for market interest rates, affecting the economy and inflation.
- Lowering the base rate generally has the effect of lowering loan interest rates, promoting investment and consumption, and stimulating the economy, but it can also act as an inflationary factor.
- In a stagflation situation, it creates a policy dilemma between 'economic stimulus' and 'price stability.'
3️⃣ Principles and Economic Outlook
💡 Causes and Impact of Korea's Entrenchment in Low Growth
The phenomenon of the Korean economy entering a low growth phase of less than 2% for four consecutive years is the result of various structural and cyclical factors acting in combination.
First, global economic slowdown and trade contraction are acting as major external factors. The global economy is experiencing weakened growth momentum due to US-China tensions, geopolitical risks, and the impact of contractionary monetary policies. In particular, the economic growth slowdown and structural changes in China, Korea's major export market, are having a negative impact on Korean exports. In the fourth quarter of 2024, Korea's export growth rate was just 1.2%, showing that traditional export-led growth is facing limitations. Additionally, concerns about weakening export competitiveness are being raised as Korean companies face positional instability in the process of global supply chain reorganization.
Second, low growth is becoming entrenched as domestic demand continues to be sluggish. Private consumption is shrinking due to household debt burden, real estate market depression, and employment insecurity, and companies are also tending to reduce investment due to increased uncertainty. In the first quarter of 2024, private consumption growth rate was only 0.5%, and facility investment decreased by 0.8% compared to the same period last year. Construction investment is particularly sluggish, mainly due to the real estate market downturn and increased funding costs due to high interest rates. The weakening of the domestic economy is directly impacting the service industry and small business owners, forming a vicious cycle that leads to job losses and income stagnation.
Third, as structural factors, population decline and productivity stagnation are acting as the root causes of low growth. Korea is experiencing the fastest aging in the world, and the working-age population began to decline in 2021. These demographic changes negatively impact economic growth through various channels such as reduced labor supply, domestic market shrinkage, and increased fiscal burden. Additionally, productivity improvement is also stagnating due to the dualization of industrial structure and lack of innovation capacity. The widening productivity gap between large corporations and SMEs, as well as between manufacturing and service industries, is reducing the efficiency of the overall economy.
Fourth, the persistence of low growth is having a wide-ranging impact on the real economy, including jobs and income. As economic growth slows down, it becomes difficult to create quality jobs, and youth unemployment and employment instability are increasing. According to Statistics Korea, as of February 2025, the youth unemployment rate is 7.2%, far exceeding the overall unemployment rate (3.8%). In terms of job quality, there is a trend of decreasing regular employment and increasing unstable employment such as non-regular workers and platform labor. In terms of income, household income growth rates are not keeping up with inflation rates, leading to a decline in real purchasing power, which is a factor that intensifies domestic demand sluggishness.
If this low growth phase continues, there is concern that the Korean economy's growth potential will weaken and socioeconomic polarization will intensify. It is time to require a comprehensive and long-term policy approach beyond short-term economic stimulus to secure structural growth engines.
💡 Mechanism of High Exchange Rate and Oil Price Increases Affecting Inflation
The recent depreciation of the Korean won and international oil price increases are acting as the main causes of domestic inflation and are spreading through various channels.
First, exchange rate increases directly lead to higher import prices. As the KRW/USD exchange rate exceeds 1,350 won (up about 10% compared to the same period last year), import prices have generally risen. Especially in the Korean economic structure with high import dependence on essentials such as energy, raw materials, and food, exchange rate increases act as widespread inflationary pressure. According to the Bank of Korea's analysis, a 10% increase in the exchange rate is estimated to raise consumer prices by about 0.4%p. In February, the import price index rose by 3.8% compared to the same month last year, significantly exceeding the consumer price inflation rate (2.2%).
Second, international oil price increases lead to overall production cost increases along with higher energy costs. Based on Brent crude, international oil prices have risen to the $80 per barrel range, and the possibility of further increases is being raised due to heightened geopolitical tensions in the Middle East. Rising oil prices directly lead to increased fuel costs (gasoline, diesel, gas, etc.) and also add pressure for public utility fee increases such as electricity and heating. It also affects the prices of almost all goods and services through increased transportation and logistics costs. According to the Korea Energy Economics Institute, a 10% increase in oil prices is estimated to raise consumer prices by about 0.2%p. In particular, if exchange rate increases and oil price increases occur simultaneously, inflation pressure may be even greater due to the amplifying effect of these two factors.
Third, high exchange rates and oil price increases tend to transfer from producer prices (PPI) to consumer prices (CPI). Recently, the producer price index has risen by 3.1% compared to the same month last year, exceeding the consumer price inflation rate. This suggests that companies are currently unable to fully reflect the burden of cost increases in consumer prices, implying the possibility of additional transfers to consumer prices in the future. However, companies' ability to pass on prices is limited in a low growth phase, so some cost increases may lead to deteriorating corporate profitability.
Fourth, the rise in daily necessities and service prices is further increasing the perceived inflation. The price increase rates for items closely related to daily life such as food (3.5%), dining out (3.7%), and personal services (3.0%) are exceeding the average inflation rate, making consumers' perceived inflation appear higher than official statistics. In particular, low-income households spend a larger portion of their income on these necessities, widening the gap in inflation burden between income classes. This can act as a factor that deepens income inequality.
Since exchange rates and oil prices are largely influenced by external factors, they are difficult to control with domestic policies alone. Therefore, the inflationary pressure caused by these factors may be difficult to resolve in the short term, and if prolonged, it could be a factor that continuously pressures the real income of households and businesses.
💡 Stagflation Risk Assessment and Policy Response Measures
Let's assess the risk of the current situation of simultaneous low growth and inflation developing into full-fledged stagflation and explore possible policy responses.
First, the current situation differs from the severe stagflation during the oil shocks of the 1970s. Currently, Korea's inflation rate (2.2%) is much lower than during the 1970s oil shocks (over 10%), and the unemployment rate is relatively stable. Therefore, the current situation may be more accurately viewed as 'price pressure amid growth sluggishness' rather than typical stagflation. However, if low growth becomes prolonged and inflationary pressure persists, the risk of stagflation could gradually increase. In particular, if the Korean won continues to depreciate and global energy prices rise further, inflationary pressure could strengthen.
Second, in terms of monetary policy, it is important to find a balance between 'growth and price stability.' The Bank of Korea recently lowered the base rate from 3.00% to 2.75%, which can be seen as a measure to stimulate the economy. However, there are concerns that interest rate cuts could exacerbate inflationary pressure, so the decision on further cuts needs to be made carefully. In particular, if the gap with the U.S. Federal Reserve's interest rate policy direction widens, the won's weakness could intensify, increasing import price pressure. Future monetary policy should be determined comprehensively considering not only domestic economic and price conditions but also global monetary policy trends and financial market stability.
Third, a complex approach through fiscal policy and structural reform is needed. Fiscal policy should pursue a balance between two goals: economic stimulus and supporting vulnerable groups. In the short term, tailored support is needed to alleviate the financial difficulties of vulnerable groups due to high prices, and in the medium to long term, strategic investment (infrastructure, R&D, human capital, etc.) is required to expand growth potential. In terms of structural reform, efforts are needed to improve the efficiency and dynamism of the economy through enhancing labor market flexibility and stability, improving service industry productivity, and rationalizing regulations. It is also important to strengthen the economy's resilience to external shocks by improving energy efficiency and reducing import dependence.
Fourth, foreign economic policies to stabilize the value of the Korean won are also important tasks. Although the exchange rate is in principle determined by the market, excessive volatility can undermine economic stability. Therefore, efforts are needed to mitigate rapid fluctuations in the value of the Korean won through foreign exchange reserve management, expansion of currency swap agreements, and strengthening international financial cooperation. Additionally, policies should be pursued in parallel to improve the trade balance through enhancing export competitiveness and fostering import substitution industries, and to expand foreign investment attraction to promote capital inflow. In the medium to long term, it is also necessary to consider ways to reduce vulnerability to external shocks by strengthening the international status of the Korean won.
To respond to the risk of stagflation, a comprehensive approach is required that goes beyond short-term economic stimulus and price stabilization efforts to improve the structural quality of the economy and strengthen resilience to external shocks. In particular, it is time for a policy mix that balanced pursues three goals: expanding growth engines, improving distribution, and enhancing economic stability.
4️⃣ In Conclusion
The situation where the Korean economy faces the double burden of low growth and inflation is causing serious concerns. In particular, as a growth rate of less than 2% is expected for the fourth consecutive year, concerns about stagflation are growing as inflationary pressure persists. This situation can have wide-ranging economic impacts such as reduced real household income, deteriorating business environments, and contraction of job creation.
The causes of low growth are the result of various factors acting in combination, including global economic slowdown and trade contraction, domestic demand sluggishness, population decline, and productivity stagnation. In particular, it can also be seen as the pain of structural change that the Korean economy is experiencing in the process of transitioning from an export-led growth model to one centered on domestic demand and innovation.
The main causes of inflation are the depreciation of the Korean won and rising international oil prices. As the KRW/USD exchange rate exceeded 1,350 won, import price pressure increased, and rising international oil prices led to increased energy and logistics costs, promoting overall inflation. These price increases caused by external factors are difficult to control with domestic policies alone, intensifying the central bank's policy dilemma.
The Bank of Korea has cut the base rate to respond to this situation, but this could be a double-edged sword. While interest rate cuts can help stimulate the economy, they may exacerbate inflationary pressure and deepen the weakness of the Korean won. In particular, if the interest rate gap with the United States widens, there are concerns about additional price pressure due to capital outflow and exchange rate increases.
To effectively respond to the risk of stagflation, structural reform is needed beyond short-term economic stimulus and price stabilization efforts. Strengthening innovation capacity, improving productivity, and enhancing energy efficiency emerge as medium to long-term tasks for expanding growth potential. At the same time, tailored support to alleviate the financial difficulties of vulnerable groups due to high prices should also be pursued.
Ultimately, the current economic situation shows both the short-term difficulties faced by the Korean economy and the structural task of transitioning growth models. Improving the economic structure vulnerable to external shocks and seeking a sustainable growth path through domestic demand and innovation will be the long-term solution.