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MC Escher rules for Japan Credibility

January 27, 2011

One of the big ideas within Paul Krugman’s book “The Return of Depression Economics” involves deflation fighting tactics for Central Banks.  He makes a pretty good argument that Central Banks have become too credible in their inflation fight. Because of their relative success in fighting inflation over the last 50 years (20 years at the time of publishing, 30 years now), Central Banks are perceived as very credible when they want to contain inflation.

Paul’s response was that this inflation fighting credibility harms them in a fight against deflation.  Since people know that central banks will take away the punch bowl as soon as the party gets started, it makes it hard for them to be credible when they say “We’re targeting inflation at 2%.”

Today’s news that Japan has had their debt downgraded is a bit funny, because it means that Japan is slightly less credible.   While this has nothing at all to do with Japans Central Bank, country-wide credibility is part and parcel of the credibility of the central bank.  Can you picture a country with a perfectly credbile central bank, but a treasury that spends way out of control?

Then, on a related note, we have the news that Moody’s used 4% housing price increases for their models.  Now this is just silly.  It is not credible.  It is a non-realistic assumption that anyone with a brain could easily see.  Not only that, but they had access to data from California – the biggest real estate market in the United States – that showed them a significant housing price decline.

So we have a situation where the Credibility of Japan is being questioned by firms with very questionable data modeling skills.  Still, these people without much credibility are taken seriously.  Japan is losing credibility.

But isn’t this Japan’s goal – to be less credible?  They are mired in a multi-decade fight against deflation.  Which according to Paul Krugman, requires them to be not credibile in their fight against inflation.  How can they realistically be fiscally credible if they want to fight their deflation?  So Japan must try to destroy their credibility a bit, by convincing people who have been exposed as not credible credit analysts, that they do not have good credit and won’t be able to fight inflation.

Strange, aint it?


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