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CIRJE-F-894
The Response of Asset Prices to
Monetary Policy under Abenomics
Kazuo Ueda
University of Tokyo
July 2013
June 2013
The Response of Asset Prices to
Monetary Policy under Abenomics*
Kazuo Ueda
The University of Tokyo
Summary
In this paper I investigate the causes of the recent sharp response of the yen and
Japanese stock prices to the discussion of, and the subsequent implementation of bold
monetary easing by the Bank of Japan as demanded by Prime Minister Abe. I present
statistical evidence that the response of the two asset prices have indeed been unusually
large relative to the past experience with NCM even after allowance is given for the rise
in global economic activity and asset prices. I also point out that the rally has been led
by speculative trade by foreign investors while domestic investors have largely stayed
on the sidelines. I discuss possible backgrounds for such foreign investor behavior.
Simply put, the unprecedented political pressure raised hopes of the adoption of bold
measures by the Bank. I discuss, however, the possibility that the room for further
action by the Bank is quite limited apart from what might be called a targeted helicopter
drop of money. I also point out the possibility that investor behavior
has not been based on economic fundamentals. The asset price volatility
since April 2013 is interpreted in the light of such discussions.
*The author would like to thank Kazumasa Iwata, Kosuke Aoki and the editors of
the journal for helpful comments on an earlier version of the paper. Financial
assistance from CARF at the University of Tokyo is gratefully acknowledged.
2
In late 2012 Shinzo Abe, then the President of Japan’s Liberal
Democratic Party, started to place unprecedentedly strong pressure on the
Bank of Japan (BOJ) to ease monetary policy aggressively. The Bank
would lose independence, he argued, unless it complied. The BOJ
responded in early April 2013 by announcing “quantitative and qualitative
easing (QQE),” which involved huge purchases of long-dated Japanese
government bonds (JGBs) and ETFs, and a promise to increase base money
by 100% in an attempt to hit a 2% inflation target in two years. Such a
chain of events regarding monetary policy has created surprising
movements in asset prices. Between mid-November 2012 and mid-May
2013 the yen weakened by 25 % and Nikkei 225 rose by 80 %. Since then,
both markets have seen a substantial correction.
Such a response of asset prices has been surprising because they
hardly responded to easing measures adopted by the BOJ during years
2010-2012, which involved purchases of the same set of assets, although
the size of purchases was not as large as in the most recent package. More
broadly, central banks in developed economies have doubled or tripled
their balance sheets since the economic and financial crisis of the late
2000s. Nominal GDP of these economies have shown almost no correlation
with such movements in base money.
In this paper I discuss the backgrounds for large asset price
movements in Japan during the last few months. The discussion
emphasizes two noteworthy features of the current episode. One is the
enormous political pressure placed on the BOJ. Huge political pressure on
a central bank has always been a necessary condition for a high rate of
inflation. I discuss whether such a consideration is important in the current
Japanese context.
The other feature of the asset price response has been the
contrasting response of foreign and domestic investors. Foreign investors,
especially the fast money community, have sold the yen and bought
Japanese equities on a large scale, while the domestics have largely stayed
on the sidelines. The behavior of foreign investors seems to have been
based on the view that aggressive use of NCM, even if it does not lead to
improvements in the real side of the economy, is capable of raising asset
prices. The view must have been based on investors’ experience with the
easing carried out by global central banks, especially the Fed and the ECB.
3
I argue that the view contains an element of irrationality. It does not seem
to distinguish between different types of NCM properly. Thus, investors
may have shown a sunspot type response to the prospect of, and the actual
large BOJ easing without a deep understanding of the workings of NCM.
In order to establish these points I devote the first half of the paper to
the discussion of the past experience of central banks with NCM, especially,
that of the BOJ. I start by offering a typology of NCM that includes a brief
discussion of the theoretical rationale for each measure as well. I then carry
out a simple regression analysis of the effectiveness of the Fed’s and the
BOJ’s NCM in an attempt to show that the asset market response during
the last few months in Japan was surprising in light of earlier experiences. I
also present some evidence of irrationality of investors.
Based on such a technical analysis, I offer, in the second half of the
paper, some informal discussion about why asset prices have responded in
the way summarized above to the political pressure on the BOJ, and the
actual implementation of NCM. The discussion first emphasizes the
contrast between foreign and domestic investors. I then proceed to the
backgrounds for speculative trades carried out by foreign investors and
offer several explanations including the possible irrationality of investors. I
also interpret the volatility seen in all markets since the inception of QQE
in the light of such explanations. The paper’s discussion is mostly confined
to the relationship between asset prices and NCM. The relationship
between the real economy and NCM will be only briefly discussed.
1, A Typology of Nonconventional Monetary Policy Measures
Let me start by defining the terminology used throughout the paper
and at the same time offer a brief summary of theoretical arguments for and
against the effectiveness of NCM.
2
NCM central banks have adopted can
be classified into “large scale asset purchases”, “quantitative easing” and
“forward guidance of interest rates and or future asset purchases.” Large
scale asset purchases, in turn, consist of those in distressed markets and in
more normal markets. The term “large-scale asset purchases” is usually
used when the central bank is concerned with what type of assets it
purchases, while “quantitative easing” is used when the bank is more
2
This section draws heavily on Ueda (2012c). See also Bernanke (2012) and Woodford
(2012).
4
concerned with the size of its balance sheet. Large scale asset purchases
have in many cases been accompanied by quantitative easing, but not
always.
Large-scale asset purchases have occurred in many forms. The
theoretical rationale for such actions seems to rest on the existence of
market imperfections. During a financial crisis, a sharp decline in investors’
ability to take risks reduces market liquidity in certain segments of the
financial system. In such markets, central bank purchases of assets can
lower liquidity/risk premiums and in this way support the economy (Type 1
Large Scale Asset Purchases: LSAP1). Allen and Gale (2007), Curdia and
Woodford (2010), Gertler and Karadi (2012) discuss the usefulness of such
operations, which are sometimes called “credit easing.” In addition to
security markets, interbank markets can become dysfunctional due to
heightened counterparty risks, especially in term markets. In such a case
central banks can make term loans in order to contain risk premiums. Such
operations may also be regarded as credit easing.
Other types of large-scale asset purchases by central banks are
purchases of Treasury bonds or private financial instruments in more
normal conditions (Type 2 Large Scale Asset Purchases: LSAP2). For
example, many central banks have purchased long-term government bonds
and expanded their balance sheets. Such an operation can be decomposed
into pure quantitative easing (to be defined below) and a so-called
“operations twist,” which is a form of LSAP2, involving the central bank
purchases of long-term Treasury bonds while at the same time selling
short-term Treasury bills. Thus, LSAP2 may or may not be accompanied by
pure quantitative easing. The operations twist part of the measure affects
the yield curve if investors in such securities are segmented or have
“preferred habitats.” The effects could spill over into other markets such as
the corporate bond market through portfolio rebalancing effects. Whether
such “market imperfections” exist has long been debated. It seems fair to
say, however, that no consensus has emerged yet.
Some have argued that irrespective of what a central bank buys, an
expansion of the central bank balance sheet generates an easing effect by
itself. An example would be central bank purchases of Treasury bills, a
plain vanilla instrument, in order to supply liquidity beyond the level
required for a zero percent policy rate. In the following let me call such
