Korea Still Has Sufficient Fiscal Space… ‘Aging Population’ is the Biggest Variable

[By Jeong-yoon Lee, Edaily] The U.S. fiscal crisis is unlikely to trigger as a sudden financial market collapse. Instead, but rather more likely to progress gradual pressure through rising interest rates and accumulating fiscal deficits. At the same time, experts evaluate that Korea still has fiscal room to respond, making the current situation the “golden time” to implement structural adjustments.

Alan Auerbach, Professor of Economics at the University of California, Berkeley

Alan Auerbach, a world-renowned authority in fiscal policy and tax economics and a professor at UC Berkeley, recently described the current U.S. fiscal situation as “still manageable” in an interview with Edaily.

Professor Auerbach stated, “There are feasible policy options to make fiscal policy sustainable.” He noted that permanent spending cuts or revenue increases equivalent to 2% of GDP would be necessary to stabilize the debt-to-GDP ratio. “This is an economically achievable level,” he emphasized.

He predicted that the U.S. fiscal crisis would emerge gradually rather than explosively. “It is more likely to be a slow-moving process,” he said. “There is no tipping point where the financial market suddenly collapse overnight due to the fiscal crisis. Instead, Treasury yields will rise gradually.” He added, “As long as the actual risk of default remains low, there is no reason for the U.S. to experience a financial crisis.”

Despite the accumulating fiscal burdens, the low likelihood of it escalating into a financial crisis suggests that the U.S. will likely continue to retain its status as a global safe-haven asset market.“ Since other major countries are in similar or even worse fiscal conditions, the U.S. will relatively remain a safe haven,” he explained. “Given the limited alternative investment options, demand for U.S. Treasuries will remain relatively attractive as a safe asset.”

Recent geopolitical risks, specifically the rising military tension between the U.S. and Iran, were identified as factors that could accelerate this fiscal pressures. Professor Auerbach pointed out, “Rising defense expenditures would expose fiscal problems much faster,” noting that “Spending is rising without corresponding fiscal adjustments elsewhere.”

He also gave a negative assessment of U.S. tariff policies from a fiscal perspective. “While tariffs generate revenue, the economic costs far outweigh the revenue, so they do not bring net gains,” he stressed. “The economic distortion costs are extremely large.”

Regarding Korea, Professor Auerbach offered a relatively positive assessment while cautioning about aging as a major risk. However, he warned that aging-related spending pressures must not be underestimated. “Korea must take into account the structure of increasing expenditures, including pensions due to population aging.”

According to the International Monetary Fund (IMF), Korea‘s general government debt-to-GDP ratio stands at 54.4% this year. While this remains significantly lower than the G7 average of 120~130%, Korea, not being an issuer of a global reserve currency, remains more vulnerable to external shocks and therefore requires relatively strict fiscal management.

Nevertheless, he drew a line regarding prolonged expansionary fiscal policy. “Temporary fiscal expansion may be justified in response to short-term needs, but there is little reason for such expansion to continue for many years.” He explained, “Economic stabilization policies and long-term fiscal sustainability should be treated separately.”

Finally, he emphasized taking a “long-term perspective” as the standard for fiscal policymaking. “Fiscal sustainability should be evaluated using long-term indicators,” he said. “If demographic changes are expected to increase expenditures, governments should reflect this in advance and respond gradually.” He added that “building up reserve funds in preparation for future cost increases could also be one effective approach.

About Professor Alan Auerbach…

△ B.A. in Economics, Yale University △ Ph.D. in Economics, Harvard University △ Former Professor, Massachusetts Institute of Technology (MIT) △ Former Professor, Wharton School, University of Pennsylvania △ (Current) Robert D. Burch Professor of Economics, UC Berkeley