Recent movements in financial markets are far from ordinary. The stock market has been on a rollercoaster ride, and the won-dollar exchange rate has surpassed 1,500 won. This financial market instability signals that the impact of surging oil prices driven by the Middle East conflict on Korea's macroeconomy is deeply serious. As a thick sense of crisis hangs over the Korean economy, the government is swiftly pushing a supplementary budget that includes "high oil price damage relief funds." The déjà vu this response evokes stems from memories of the COVID-19 pandemic that plunged the world into crisis in 2020. What is the same as then, and what is different?
The COVID-19 crisis was an unprecedented economic shock in which both demand and supply collapsed simultaneously. Such a shock causes severe recession without significantly affecting prices. At the time, central banks and governments around the world slashing interest rates drastically and expanding large-scale fiscal spending and cash support were unavoidable choices to prevent economic collapse.
By contrast, the current oil price surge originating from the Middle East is a shock characterized by a sharp contraction in supply — far exceeding any decline in demand — driven by rising production costs and supply chain disruptions. Korea, which imports 100% of the crude oil it uses, is fully exposed to the impact of surging oil prices. This makes "stagflation" — a deteriorating economy coupled with rising prices — highly likely. Pumping money into the economy under these circumstances will push prices up before any economic recovery takes hold. Ultimately, this leads to yet another inflation crisis.
Multiple studies analyzing the COVID-19 crisis have already warned of this possibility. The Federal Reserve Bank of San Francisco found that the large-scale fiscal support implemented in the United States in response to the COVID-19 pandemic raised U.S. inflation by approximately 3 percentage points by late 2021. The Korea Development Institute (KDI) also estimated that expansionary fiscal policy after COVID-19 lifted the inflation rate in the second half of 2022 by 0.7 percentage points. These studies do not deny that fiscal spending played a role in supporting economic recovery. Yet we must reconsider whether large-scale cash support and fiscal expansion are the only solutions for the current crisis, which is driven by a supply shock.
Surging oil prices have a greater direct effect of contracting supply, but they also indirectly affect demand. When oil price surges push up inflation, households' real income declines, leading to a contraction in consumption. In particular, vulnerable groups — small-scale truck owners, delivery riders, and energy-poor households whose income-generating activities are directly hit by rising oil prices — inevitably bear a heavier burden. However, if the government prescribes universal cash support, it will only stimulate demand without resolving the supply shock, further stoking price increases. This would further dampen consumption and inevitably delay economic recovery.
It is worth looking at neighboring countries with high crude oil import dependency, like Korea. Japan has implemented energy price stabilization measures such as gasoline subsidies and assistance primarily targeting low-income households. Taiwan, too, is focusing its full efforts on blocking the channel through which energy price increases pass through to broader inflation, rather than providing universal cash support. In other words, these countries are focusing policy on stabilizing energy prices instead of boosting demand.
Moreover, if inflationary pressure intensifies, monetary policy will have no choice but to pivot toward tightening. But if the government insists on expansionary fiscal policy, it could either dilute the effect of tight monetary policy or lose market confidence through policy dissonance.
Therefore, the government should first focus on targeted support for vulnerable groups and measures to stabilize energy costs and restore supply chains as early as possible, rather than universal cash handouts and fiscal expansion. At the same time, it must clearly demonstrate a commitment to policy coordination — including establishing standing communication channels among relevant policy agencies — to prevent oil price increases from becoming entrenched inflation and to strengthen market confidence in policy.
We must not forget the costly lessons from the COVID-19 crisis and repeat the misguided prescriptions of the past. What matters is not "how much" fiscal resources are spent. It is "where" they are spent that determines policy success or failure.