The Korean Economic Forum
Changes in Economic Conditions Under COVID-19 and the Effects of Fiscal Policy
Soyoung Kim (Seoul National University) and Yonggun Kim (Seoul National University)Year 2021Vol. 13No. 4
This paper briefly reviews the effectiveness of fiscal policy under low interest rates and the effects of fiscal policy under alternative financing methods, and discusses implications for the Korean economy. Previous studies suggested that an increase in government spending at zero lower bound could have a greater effect on the economy by raising inflation expectations and lowering real interest rates. This result can vary depending on a variety of factors, including the types of shocks and fiscal policy. In the case of the COVID-19, not only the demand side but also the supply side and the psychological side are causing overall difficulties in economic activities. So even if the policy rate reaches the effective lower bound, there is a limit to apply the results of existing studies on the premise of a demand shock. In addition, the effect of fiscal policy may be weaker than usual because economic activities are limited under the COVID-19. A structural VAR model using Korean data developed in past studies was used to analyze how the effect of government expenditures would change if the method of financing was changed. The results show that government spending has a greater effect on the economy with debt-financing than with tax-financing. However, it should also be noted that the risk premium could rise, which adversely affects the economy in the long run as government debt continues to grow under expansionary fiscal policies with debt-financing.