The Wall Street Journal is gleefully proclaiming the death of Abenomics:
At the root of Abenomics is a false theory that Japan’s economic malaise results from a lack of confidence produced by deflation. Mr. Abe hoped that he could solve Japan’s problems by printing lots of money to restore inflation. So when voters go to the polls in the snap election that Mr. Abe is expected to call, they should ask themselves a simple question: If Abenomics is really so terrific, why has a delay in the tax hike become necessary? Healthy economies are not thrown into recession by a relatively small sales-tax hike to 8% from 5%. But Japan is not a healthy economy. And Abenomics has not made it healthier.
Inflation has already been restored–running 50% greater than the Bank of Japan’s inflation target. Core inflation is also up:
…due to a 3% rise in consumer prices…
…and producer prices…
…all of which stem from a single, powerful jump in April 2014:
Inflation has been restored…by the 1 April 2014 value-added tax increase. This might be something to celebrate if it wasn’t accompanied by a sharp economic downturn:
Curious is the stipulation that the Bank of Japan’s quantitative easing (otherwise known as Abenomics), not the austerity introduced this spring, was responsible for Japan’s descent into recession. The April tax increase has been mistakenly described almost exclusively as a consumption or sales tax by various media outlets when in reality it was a rise from 5% to 8% of the wide-ranging value-added tax (VAT). That the first step of two for a planned doubling of the Japanese VAT also triggered a recession should not be surprising; after all, austerity is contractionary:
Terrible numbers from Japan. Probably the drop was overstated — I don’t have any special knowledge here, but other indicators didn’t look quite this bad. But still, no question that the ill-considered sales tax hike of the spring is still doing major damage.
Fairly clear now that Abe won’t go through with round two, which is good news.
So contractionary policy is contractionary. I could have told you that, and in fact have told you that again and again. But some people still don’t get the message. In Germany, the Bundesbank president opposes expansionary monetary policy because it might reduce the pressure for fiscal austerity.
Perhaps Jens Weidmann’s opposition to expansionary policies (and the opposition from other proponents of “expansionary austerity”) stems from the economics field’s total failure to recognize the fact that austerity is not only contractionary but inflationary.
The April Fools
April 2014 was not the first time Japan suffered the effects of ill-advised contractionary/inflationary austerity. The Japanese government increased VAT precisely 17 years earlier:
The government decided the tax increase originally in late 1994 with a tax reform package called the Murayama Tax Reform that coupled a future increase in the consumption tax rate with immediate cuts in income tax rates. It set a target date of April 1997 for the consumption tax rate increase, but the legislation also stated that the rate increase would be imposed “only if the economy had sufficiently recovered”. Having judged the economy to have sufficiently recovered, the ruling Liberal Democratic Party (LDP) moved in June 1996 to pass the consumption tax rate increase. Legislation passed through the Upper House on June 25, 1996, and the rate increase was scheduled to become effective April 1, 1997.
Inflation spiked in April 1997…
…and Japan’s economy immediately sank:
The Japanese VAT was first introduced exactly eight years prior:
VAT was imposed in Japan on April 1, 1989 at a rate of three percent on most goods and services, and remained at that level until April 1, 1997, when the rate was increased to five percent.
Lo and behold, stagflation immediately followed:
Perhaps Japan should stop putting major tax policy in effect on April Fool’s Day; the results haven’t been promising over the last quarter century.
But in all seriousness, the effects of austerity are horrifyingly predictable:
The same contractionary/inflationary austerity adversity emerged on this side of the Pacific in 2011; the effects of austerity are not a Japanese enigma. During the Great Federal Budgetary Battle between the Democrats and Republicans (a conflict waged over one faction’s demand for spending cuts versus the other demanding spending cuts and tax increases) the rate of inflation more than doubled. But that is only the tip of the iceberg.
The austerity/stagflation contradiction goes back at least to the 1970s, the decade that embodies the term ‘stagflation:’
What that implied for Phase IV on the supply side were steps to increase acreage available for planting crops, licensing and export controls to assure adequate domestic supplies of feed grains, restrictions on scrap exports and accelerated disposal of stockpiled industrial commodities. What it implied for price controls was cost absorption. Phase IV was to be a move “from the freeze to the squeeze”; companies were to be forced to absorb cost increases at the expense of profits before passing them along in the form of increased prices.
Phase IV was the last stage of Richard Nixon’s ‘1,000 days’ of price controls which began on 15 August 1971. The fourth phase was implemented in the summer of 1973, and the squeeze of austerity failed miserably:
Notice that in all five historical examples the stagflationary effects come out of left field–no one was anticipating austerity until it hit (inflation spiked last April in Japan at a greater month-over-month intensity than the U.S. has ever experienced despite the fact the 2014 tax increase was announced years before it went in effect)…in each case the austerity stagflation storm striking the American and Japanese economies hard.
The 1970s also gave rise to the the idea that human beings have “rational expectations,” an explanation for the rise in the price level that accompanied crashing economic growth. This explanation seems to have been so convincing that since 1973 economists of all stripes appear to have internalized rational expectations. But the five historical episodes leads me to ask the relevant question: is human economic activity driven by future expectations or reactions to current policy?
***Update: my answer is here.***