The Strange Rise of Rational Expectations
I’ve touched on several possible sources of stagflation in the past, but am still trying to wrap my head around the evidence I’ve uncovered that austerity has a long history triggering economic contractions and rises in the price level simultaneously. Austerity, in the form of VAT increases, hit Japan on 1 April in 1989, 1997, and 2014:
The hits kept coming, striking the Japanese economy as well:
Each April instance was stagflationary, which shouldn’t surprise anyone given the truth that austerity is contractionary. What might be surprising is the fact that business confidence…
…was a lagging, not leading indicator. This year’s VAT rise wasn’t a sudden policy shift–the tax increase was passed by the Japanese legislature on 10 August 2012 under the tutelage of Yoshihiko Noda, Shinzo Abe’s predecessor. The confidence of Japan’s consumers is also perplexing:
Consumer confidence did drop prior to each VAT increase, then immediately rebounded in the face of an economic contraction. Is there any good gage, any indicator for the effects austerity will wreck on economic performance?
Ultimately, it is far more important what consumers are spending rather than concepts such as ‘confidence’ or other amorphous sentiments.
The Japanese experience demonstrates that perhaps the very concept of rational expectations is flawed. Consumer confidence crashed long before the Great Recession commenced…
…but spending did not decline until mid-2008…
…taking the economy with it:
The American experience mirrored Japan in the strange way consumer sentiment rebounded in the summer of 2008, even as the bottom was falling out. Does this indicate Americans had profoundly negative expectations six to seven years ago, or are people both behaviorally and in practice profoundly reactionary?
So what, who cares? What difference does it make whether economics is driven by proactive or reactive sentiments? One primary concern–monetary policy. With the declarations that Abenomics has failed, calls for the Bank of Japan to tighten the monetary supply are sure to follow. The Federal Reserve clearly is feeling intense pressure to raise interest rates now that QE has ended, despite the fact that inflation still isn’t cooperating with the central bank’s demands that the rate rise to 2.0%:
Before the BOJ and the Fed repeat Jean-Claude Trichet’s reign of error, perhaps it would be wise to discern how the petroleum market remains horrifically broken and the gold standard has been replaced by a far more insidious set of price controls.