'Inflation' and its greater impact on the middle class
'Inflation' and its greater impact on the middle class
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  • 승인 2023.01.17 11:45
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As high prices continue, income levels will decrease even further
Shin Ho-Cheol, Department of Business Administration professor at Hannam University
Shin Ho-Cheol, Department of Business Administration professor at Hannam University

Recently, economists in Korea have been voicing the same concerns: Korea is experiencing stagflation. 'Stagflation' is a combination of the terms 'stagnation' (economic recession) and 'inflation' (a decline in the value of money) and refers to a state in which inflation occurs at the same time as an economic recession.

This trend is made clear when we look at the consumer price growth rate, which has reached 6% for the first time in 24 years since the 1998 financial crisis. According to the June 2022 Consumer Price Trend released by Statistics Korea on July 5th, the consumer price index rose 6.0 percent year-on-year to 108.22 percent last month. Due to rising prices, Koreans are trying to reduce consumption through movements like the 'No-Spend-Challenge,' where the goal is to spend zero won each day. Other recent trends include the rise of App-Tech (app+investment techniques), living expense 'diets,' and last-minute shopping.

When prices rise, the value of money decreases. This is a phenomenon where prices rise above monetary income levels, reducing the amount of products that can be purchased with nominal income. When adjusted for inflation, nominal income becomes real income. In the first quarter of this year, the household income of urban workers increased by 6.4% compared to the previous year. However, when inflation is taken into consideration, real income decreased for the middle class, which encompasses the 2nd~4th income quartiles. The real income of middle-class households, which excludes the bottom 20% households that are supported by the government and the wealthy top 20% households, fell by about 3%. This is because middle-class workers who rely on government incomes have been hit especially hard by inflation.

Inflation is not the only factor that is negatively affecting consumption among the middle class. Workers whose salaries have risen will be included in higher taxation classes and will have to pay more income tax than before. In fact, it is rather contradictory since income levels have decreased while taxes have increased. The United States, United Kingdom, and France adjust their income tax rates every year by considering prices. The Korean government also adjusted the income tax classification system for the first time in 15 years to ease the tax burden on the middle class by lowering tax rates for more tax classes. However, this strategy has been criticized as benefiting the rich rather than the middle class. "Since 30% of workers do not pay income taxes as they have low incomes, ordinary workers can only enjoy tax reductions as high as a few hundred thousand won" said Shin Ho-Cheol, professor of Business Administration at Hannam University. He added, "this tax reform includes cutting the maximum corporate tax rate from 25% to 22%, which will reduce taxes by tens of millions of won for multiple homeowners and hundreds of billions of won for large companies."

Expectations that prices will rise further soared to 4.7 percent. Due to high expected inflation, prices of products and services continue to increase. Eventually, real income will decrease, reducing consumption and slowing the economy. With rapid inflation, workers may demand more wage increases in the future, and suppliers of raw materials and parts may also demand higher unit prices. In addition, consumers will also try to rush and consume more when prices are relatively low out of anticipation of future inflation. The problem is that each of these economic entities can actually accelerate inflation by increasing corporate costs and demand. "The Bank of Korea is trying to lower expected inflation by aggressively raising the base interest rate to show the central bank's willingness to respond to inflation stemming from different economic entities," said Professor Shin Ho-chul.

What can an individual do at home to help stabilize high prices and expected inflation? In theory, if the government cuts fiscal spending and if the central bank raises interest rates to reduce aggregate demand, prices will fall. Also, if productivity improves due to corporate innovation, real income can increase and prices can fall. However, these methods certainly have their limitations. Therefore, this battle requires a collective effort of cutting tariffs, raising interest rates, expanding international supply chains, reducing intermediate distribution stages of agricultural and livestock products, releasing government stockpiles of raw materials, and removing entry regulations in various sectors. "If people expect high inflation, prices can actually end up rising because they act based on the expectation that prices will become higher. So, if we can lower the expectation of inflation among economic players, it will help stabilize prices," said Park Eui-Hwan, professor of Business Administration at Hannam University. Although the world's central banks are currently implementing policies such as raising interest rates and collecting liquidity in the market to curb prices, challenging times are expected for the global and domestic economies. However, if we can stabilize prices and remove uncertainties caused by the War in Ukraine and COVID-19, perhaps the economy can gradually recover to a healthier state.

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