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Keynesian Malpractice

11/19/2014

A few years ago, the flaccid Japanese government decided to take a Keynesian approach to end their “lost decade(s)” and applied a huge stimulus, using deficit spending.  Predictably, the economy strengthened and their stock market boomed.

Now, a “true” Keynesian knows that deficit spending has to be temporary, followed by budget surplus, to keep the debt level low.  Given that their debt-to-GDP is almost twice as problematic as the U.S., they really did need to start reducing the debt.

So, earlier this year, they raised the sales tax by 60% from 5% to 8%.  Of course, it was expected consumers would respond with less spending, but economists were stunned by the large 7.2% drop in Q2 GDP.  They argued it was a one-time response and predicted Q3 GDP growth of 2.1%.  Instead, GDP dropped 1.6% last quarter, and the economists were stunned again.

My first thought was — how can Japanese economists be so bad?  My second thought was that — what, governments can do something, anything?!?!  But, the more important thought is – sure, the economy strengthened after the stimulus package but they didn’t give it enough time to normalize before applying a LARGE tax increase.  While I applaud their courage in applying the unpopular part of Keynesian economics, i.e., raising taxes, a responsible Keynesian would have given the economy more time to strengthen before applying a much smaller tax increase.

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