The first half of the 1980s was probably the most successful stabilization period in Korean history. The inflation rate in terms of the Consumer Price Index (CPI) that hovered around 20 percent per annum was stabilized to around 3 percent from 1983. ##MORE_LAYER_BOX##Along with prices of consumers and producers, feverish speculation on real estate began to subside and their prices were also stabilized.
[Inflation Rates (percent)]
Source: The Bank of Korea##MORE_LAYER_BOX_END## As inflation subsided, factor prices such as wages and interest rates were also stabilized. Economic agents began to realize that a lower increase rate in nominal wages and a lower nominal interest rate could secure higher real purchasing powers, if inflation rates were sufficiently stabilized. For example, the real growth rates of wages in terms of purchasing power were even higher in the first half of the 1980s with around 3 percent inflation rates than in the second half of the 1970s with around 20 percent inflation. The same was true for interest rates.
Inflation stabilization also made a great contribution to resolving the balance of payments crisis that overshadowed the Korean economy. Foreign debts to finance trade deficits explosively increased in the 1970s, amounting to 48.2 percent of GNP by 1980 when the trade deficit substantially deteriorated due the Second Oil Shock. The first response of the government to cope with the crisis was to devalue the exchange rate from 484 to 580 won/dollar in January 12, 1980. In addition, subsequent stabilization of nominal wages substantially lowered the rate of increase in unit labor cost (= wage divided by labor productivity) from 20 percent or more per annum in the 1970s to around seven percent in the early 1980s, recovering exporters’ competitiveness. As price competitiveness of exporting firms improved, trade account narrowed its deficit and finally turned around into a surplus of 4 percent of GNP in 1986 --- the first time in Korea’s history. The size of surplus continued to expand to over 6 percent of GNP in 1988, resolving the balance-of payments problems. Korea’s current account was sensitive to real effective exchange rate (a higher number indicates a weak currency value). The weakening of the Korean won in the 1980s was initially driven by the nominal exchange rate devaluation, then by the domestic inflation stabilization from 1983, and the Japanese yen’s appreciation from 1985. ##MORE_LAYER_BOX##
[Current Account to GDP Ratio and Real Effective Exchange Rate (percent)]
Source: Cha, Dong-se (1995), A Half Century of the Korean Economy: Sourcebook ##MORE_LAYER_BOX_END##
As inflation was stabilized and export competitiveness was secured, the Korean economy regained its growth momentum. The Korean economy could continue to grow at a 10 percent rate per year during the 1983~85 period, and further thrived with almost 12 percent of annual growth during the 1986~88 period. In fact, the three years from 1986 to 1988 were the most memorable heyday of the Korean economy: it enjoyed fast growth, maintained low and stable inflation, and achieved sufficient amounts of trade surplus to resolve the balance of payments problem.
The Korea’s experiences in the 1970s and 1980s proves the point that inflation is not a necessary evil for growth in the long run: the average growth rate was similar over the two decades (9.1 percent in the 1970s vs. 9.6 percent in the 1980s), while the inflation rate was dramatically stabilized (16.5 percent in the 1970s vs. 6.4 percent in the 1980s). ##MORE_LAYER_BOX##
[Inflation and Growth: Case of Korea (percent)]
Source: The Bank of Korea##MORE_LAYER_BOX_END##