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Impact from Changing Internal and External Conditions on Korea’s Consumer Prices

Sora Chon 2016/12/06
■ The disinflation in recent years has been significantly influenced by the changes in external conditions and sagging domestic aggregate demand. For 2017, inflation is projected to remain at a low level.

○ An empirical analysis found that fluctuations in consumer prices are significantly influenced by domestic aggregate demand pressure shocks while external factors such as international oil prices and global aggregate demand pressure play a major role in the trajectory of domestic inflation.

- In particular, the disinflation since 2015 has been led by the changes in external factors, implying that the recent domestic stagnation and disinflation may have been caused mainly by external factors.

○ Meanwhile, given the macroeconomic conditions at home and abroad, Korea’s inflation is expected to stand at a low 1%-range, still hovering below the target.

■ Therefore, monetary policies should maintain an easing stance and active countermeasures against downward economic and inflationary pressure should be implemented when necessary.

○ Oil prices are expected to rise gradually. However, the weakening of external and internal demand resulting from the recent stagnation in the domestic economy and a global economy exposed to downside risks from the political uncertainties in the US, amongst others, will most likely limit any gains in Korea’s inflation.

○ To tackle the prolonged period of low inflation, the monetary authorities should implement active measures to increase inflation according to inflationary prospects and economic changes.

- With Korea’s long-term interest rates projected to rise, domestic monetary policies should be further eased to tackle any mismatch between inflation and interest rate as the resultant increase in the real interest rate could drag down the overall economy.

- If inflation reaches the target, this could mitigate the downward pressure on asset prices, helping the real estate economy to have a soft-landing.
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