From the “Meeting Report” section of the Fall 2015 Brookings Papers on Economic Activity:

”Fredric Mishkin elaborated on the issues that discussant Adam Posen had raised…

…regarding how demoralizing the outcomes from Japanese monetary policy have been. He had felt more strongly than Posen that expectations were very important and that managing expectations is a key element in good monetary policy. He and his colleagues expected much stronger effects in Japan from the expansion of its monetary policy. Japan’s outcome might demonstrate that raising inflation expectations is much more difficult than lowering them, and moreover this might be true globally.

Acknowledging that he is known to be a big proponent of inflation targeting, Mishkin said that when the focus is on how to keep inflation expectations down, it has worked well. But he and others have found it much more difficult to raise expectations, particularly during a long period of deflation. He noted that the general view about New Zealand’s experience is that the policy there anchored inflation expectations, that it had an expansionary impact by raising inflation expectations and thereby getting people to spend more. Yet one can see how difficult it has been to get the Japanese consumer to do the same…

”Brad DeLong seconded Mishkin’s comment…

adding that the macroeconomic situation in Japan has not developed necessarily to Japan’s advantage even though economists had strong reasons to think the expectations channel was present based on historical examples. In the 1930s, Franklin Roosevelt’s New Deal and Neville Chamberlain’s announcement as Chancellor of the Exchequer that his policy was to restore Great Britain’s price level to its pre-Depression state both demonstrated the power of the expectations channel. Indeed, the same happened when Japanese Finance Minister Takahashi Korekiyo announced his decision to go for reflation in Japan in the 1930s. It is a great puzzle that this time around it has not been working…

Indeed.

Add the failure of Abenomics to perform as expected–at least, as I had expected–to my list of major career analytical howlers, along with:

  • Central banks have the power and the will to return North Atlantic nominal GDP to its pre-2008 growth path…
  • Subprime is too small a market to be a major source of systemic risk…
  • Repealing Glass-Steagal would lead to a more efficient and less lavish and disruptive Wall Street…
  • NAFTA will tend to strengthen the peso, as capital is now attracted by guaranteed tariff- and quota-free access to the largest consumer market in the world…

The failure of Abenomics to perform as expected may well be the analytical error that is the sign of the deepest and most significant flaw in my Visualization of the Cosmic All. Ever since I was 20 or so I have operated with the rules of thumb that labor-market expectations are by and large backward-looking well financial-market expectations are by and large forward-looking. These rules of thumb have served me relatively well in the past. But they are not serving me well today.

Yes, I have long known that there is a noise trader term in asset prices. But I’ve always taken it to be a persistent additive deviation from the forward-looking expectational equilibrium price fundamental. It now seems that this is not good enough to help me properly understand the world. But with what should I replace it?