The Prospect and Transmission Dynamics of China's Inflation to Korea

Abstract

Korea’s consumer prices have increased beyond the inflation target (3.0±1%), which has resulted in growing concerns over inflation. - The increase is attributable to price run-ups in agricultural and livestock products, driven by a sharp increase in global commodity prices, extreme weather, and the spread of foot and mouth disease. The upward trend of major price indices in China, Korea’s largest trading partner, is heightening worries over price instability. - The significant rise in Chinese consumer prices is due to surges in housing rents and food expenses (agricultural and livestock products). - In addition, increases in the prices of international raw materials and in the wages of Chinese workers are adding to supply-side inflationary pressure. Given the large amount of Korea’s imports from China, a rise in production costs in China can result in inflation in Korea. - Higher production costs in China, stemming from accelerated commodity prices and the policy to raise minimum wages, will push up the price of imported goods to Korea, and thus affect Korea’s consumer prices. - The appreciation of the yuan is also driving up Chinese export prices. It is found that Chinese inflation in 2010 preceded inflation in Korea by about seven months. - China entered a high inflation phase in February 2010; Korea began experiencing a high inflation regime in September of the same year. Empirical analysis reveals that Chinese inflation had no significant impact on Korea’s inflation rate in the 1990s, while it became one of the main external causes of Korea’s inflation along with oil prices in the 2000s. - A 1 percent rise in Chinese inflation results in a 0.13 to 0.15 percent increase in Korea’s inflation rate after three months and has persistent effects in Korea. As other emerging economies have also been suffering from rising prices since the second half of 2010, measures to ward off global inflation are necessary. - When there are signs of price instability, micro-policy measures targeting specific markets are required to curb inflation expectations and contingency plans should be devised to stabilize prices as well.