The last time Japan increased its sales tax rate in an effort to get its fiscal “stimulus” deficit under control was 1997. It was, in part, responsible for ZIRP and the perpetual QE that followed. These days Japan’s economy functions in a similar state of decrepitancy that has “forced” the Bank of Japan to reach further into the activist policy manual. To create a solid foundation for economic growth requires, they presume, inflation and intentional price instability.
When the decision for the tax increase was made over the weekend, Japanese Prime Minister Abe used the latest headline inflation data as a “tailwind” providing support for that decision. Since central banking in the modern incarnation is nothing more than a monetary psy-ops, the fact that headline inflation finally broke in his direction fit the preferred narrative.
In the real world, however, academic theory is confounded and now angered by the behavior of the private economy. Ex fresh food, headline inflation did, in fact, rise 0.8% Y/Y, seemingly in step with the central bank goals. But all of that price increase was “bad” inflation, coming largely from the energy sector as Japan remains largely crippled in terms of energy production. Stripping out energy costs, inflation was still deflation. Year-over-year prices ex food and energy actually declined 0.1% in August.
On the other side of the equation, the piece that actually should be the primary focus, Japanese wages continued their stubborn decline. Regular wages have fallen, through August, for fifteen straight months. That makes the electricity price increases, thanks to the weakened yen, all the more difficult to digest, and thus counterproductive toward an actual economic foundation that is sustainable.
Frustrated by this un-modeled result, policymakers continually blame the private economy for not following the “preferred” path. In the orthodox view, inflation expectations anchored to policy leads to a predictable and very beneficial result. By encouraging businesses and consumers to believe in future inflation, it is fully expected that said businesses will move up production as a cost management tool (before input costs rise and harm profitability) while consumers move up purchasing activity for goods before prices increase. That, as the textbook assures, will lead to the virtuous cycle of spending and producing that we call a healthy economy.
This is rational expectations theory, forming the core of orthodox monetary economics since the Great Inflation. Like so many other academic rules in the “science” of economics, there are variations in the real world that are never contemplated by its practitioners. It should not be so difficult to surmise that businesses might react to potential inflation by cutting costs through other means, like managing staff levels or reducing wage rates as much as possible. Moving up production would only be a realistic option where businesses were reasonably assured of consistent demand.
That last part sounds like it would fit in the psychological scheme, after all the central banks are counting on businesses believing in QE. In reality, however, these kinds of appeals to intentional inflation and currency devaluation are really forms of instability. Businesses understand, where academic policymakers refuse to, that customers respond negatively to instability, intentional or not. That is most assuredly the case as such instability drags on over time – like when “emergency” measures linger for five or ten years, perhaps decades.
One of Japan’s primary real world problems is the movement of production offshore (catching up to the Federal Reserve’s impacts on US production). This is not a short-term measure, as businesses that engage offshoring are looking at the longer-term picture and most certainly reacting to their own non-academic policy expectations. A weaker yen means better business overseas – customers do not have to worry about intentional currency instability while the Japanese firm gets an accounting boost to profits (the great monetary/weak dollar lesson learned and demanded by the US multi-national).
The results are predictable. The domestic economy falters as businesses move out and consumers are unable to bridge the price/income divide that is consistently pushed against them (again, similar to the US).
Despite the outward appearance of Abenomics on target, confidence among Japanese consumers has fallen for three consecutive months, while merchant confidence has declined for five. Now with the tax increase a reality, we will see how consumers and businesses react to the double hit of “bad” inflation and rising tax rates.
The pathology of this flawed theory traces back to the cult of aggregate demand. Orthodox policy is determined to “create” demand through monetary means, with a total disregard for how that may distort “supply”. The Bank of Japan weakens the yen to increase demand for the country’s exports, but instead vastly increases the incentives for that export productive capacity to move out. Not only does the latter cancel any minimal gains from the former, it is a by far a net negative. Businesses and marginal job growth leaves, while domestic producers micromanage costs rather than risks (that create growth opportunities). All of it leaves the household sector further and further behind.
The vice of policy is applied as a feedback loop – as it all fails policymakers only appeal to more monetary/demand measures. Rinse. Repeat.
At least there is one real world certainty, taught by the lessons of recent (and not so recent, going back to the early 1990’s) history. Should it all fail (again) we can count on policymakers doing it all again in a few years. They surely won’t be revising any theories.
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