This paper draws out the parallels between Korea and Japan in terms of demographics, potential
growth, balance sheets, asset prices and inflation. Korea’s demographic trends seem to track
Japan’s with a lag of about 20 years. Low productivity in the service sector and labor market
duality are common to both countries and need to be addressed with structural reforms. While
Korea’s corporate balance sheets are stronger than Japan’s in the early 1990s, Korea needs to
progress with the restructuring of nonviable firms to avoid the adverse consequences of delayed
balance-sheet repair that Japan experienced. Given its strong fiscal balance sheet position, Korea
can afford using fiscal policy actively to incentivize corporate restructuring and structural
reforms and cushion their possible short-term adverse impact. Korea can prevent bubbles in asset
prices that were at the origin of Japan’s initial crisis with the continued use of macroprudential
policies. Although Korea does not appear to be headed toward deflation, new econometric
analysis presented in the paper suggests that aging will exert a downward drag on its inflation
going forward.
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