Introduction

This paper examines fiscal policy issues in the Republic of Korea (hereafter Korea) after the 2009 global financial crisis, including the timing of fiscal policy responses, the effectiveness of expansionary measures, and the long-term implications for government debt.

As in most other countries, fiscal policy turned expansionary in Korea after the onset of the current crisis. While government expenditure increased by 15% in 2009, revenues increased by only 2% in nominal terms. As a consequence, the consolidated budget balance and operational budget balance of the central government a share of gross domestic product (GDP), were -2.1% and -5%, respectively, in 2009, and they are expected to be -0.4% and -2.9%, respectively, in 2010. It is widely recognized that the sizeable fiscal stimulus has contributed to Korea’s rapid recovery. For example, the International Monetary Fund (IMF) estimates that the fiscal stimulus added 0.9-2.8 percentage point to baseline GDP growth in the first half of 2009. In this paper, I attempt to summarize fiscal policy developments in Korea since last year and assess how effective fiscal policy has been in curbing the impact of the global crisis. In particular, I conduct an empirical analysis using historical data from the Republic of Korea and other countries and derive stylized patterns on counter-cyclicality of fiscal policy and its role in the recovery process. Using these patterns, I am able to evaluate more accurately Korea’s fiscal response since late 2008. My analysis suggests that Korea’s fiscal stimulus, while having contributed greatly to the economy’s fast recovery, was unusually large compared with fiscal responses during other periods of recession.

To help us assess the possible long term implications of expansionary fiscal policy, I provide a review of existing studies on the sustainability of fiscal debt in Korea. Prior to the 1997–1998 Asian crisis, fiscal policy was not actively used as a stabilization tool in Korea, and thus fiscal deficits or government debt were not issues of primary concern. After the 1997–1998 Asian crisis, however, the trend changed and government debt started to increase rapidly. The current expansionary fiscal policy by the government will further accelerate this rising trend in government debt. I investigate whether the rapid increase in Korea's fiscal debt burden is admissible using conventional theoretical frameworks.

Moreover, I will attempt to assess what policy frameworks are needed to secure long-term fiscal sustainability in Korea. I suggest that implementation of more fiscal rules, such as automatic stabilizers and reforms in the national pension system, can be important.

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