Assessment of Deflation Risk in Korea

Author : Woong Kim 
 

  Due to the global financial crisis, inflation in major countries such as the U.S., Europe and Japan is on the decline, and some agencies forecast inflation in major countries to be in a negative territory. These phenomena are exacerbating the concerns about deflation risk. If deflation, which is generally perceived as long-run economic recession, becomes widely contagious, it could severely affect the financial markets and might serve as a factor seriously rattling economic agents' confidence about market conditions.

  Recently, with the growing concerns about the economy deteriorating more than expected, some are raising the possibility of deflation. On the basis of annual average changes, negative inflation (consumer price basis) has never been recorded in Korea since 1966. However, if the global economic downturn deepens and persists in the long run, it is difficult to deny the possibility that, starting largely with some commodities, inflation could slow down sharply. This study strives to assess the risk of deflation in Korea by calculating it into concrete figures, based upon the methodology used by the International Monetary Fund, and other econometric analyses.

  On an end-of-2008 basis, the risk of deflation in Korea is evaluated by using a variety of methodologies such as the IMF Vulnerability Index and the distributional characteristics of price changes. The results show the possibility of deflation to be extremely slim. Furthermore, according to the analysis of both the upside and downside risk probabilities of inflation occurrence in 2009, former seems greater than the latter.


JEL Classification Number: C5, E31, E37
Keywords: Deflation, Inflation, Monetary policy