There is widespread concern that Korea may face, in the second half of 2008, stagflation - economic slowdown coupled with rising prices. Led by rises in import prices, consumer prices in the second half are expected to increase by 5.6%, the sharpest jump since the second half of 1998. The dramatic rise in the overall price level is likely to further erode consumer sentiment and limit economic growth to 3.3% in the second half of this year.

Accordingly, the top policy priority now should be to maintain or manage price stability. If the current trends continue, inflationary expectations would inevitably come to the fore and set in motion the vicious cycle where higher price levels prompt a rise in wage, which in turn increses the inflationary pressure. In order to avoid this situation, the authorities should firmly commit to stabilizing foreign exchange rates and freeze the policy interest rate. That would send a strong message to the market and help tame inflationary expectations. Furthermore, short-term support measures are needed for the economically disadvantaged class to cushion the blow of the declining real economy.

As difficult as it might be, current economic conditions cannot be an excuse to delay implementing the reform measures President Lee had promised during his campaign last year. Regulatory reforms and privatization of public enterprises should continue as planned to enhance efficiency of the overall economy. Furthermore, creating an investment-inducive environment and improving labor market flexibility remain urgent policy initiatives. It is also crucial to firmly establish the rule of law as a prerequisite for sound and efficient functioning of the market economy. only when all these problems are resolved will the nation be able to expect a favorable turn of the economy in the future.

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