THE RELATIONSHIP BETWEEN EXCHANGE RATE AND STOCK PRICES DURING THE QUANTITATIVE EASING POLICY IN JAPAN

ABSTRACT Japan experienced unprecedented recession and deflation for more than 10 years. The Bank of Japan enforced quantitative monetary easing at a level never seen before. One purpose is to influence stock prices for economic recovery. Recently, the Japanese economy has been in recovery, and stock prices have increased. However, there is much dispute over whether quantitative easing has been effective. This paper investigates the relationship between macroeconomic variables and stock prices. Exchange rate is the main target variable and finds that interest rates have not impacted Japanese stock prices but exchange rates and U.S. stock prices have. Furthermore, the Bank of Japan's policy for overcoming recession and deflation has been effective. JEL Classification: F31, G15 Keywords: Exchange rate; Interest rate; Japan; Stock market; U.S.A. I. INTRODUCTION Japan experienced unprecedented recession and deflation for more than 10 years. During that period, Japan enforced very aggressive fiscal policies, and the Bank of Japan (BOJ) performed unprecedented quantitative monetary easing. Since 2001, the BOJ has conducted quantitative easing (Kurihara, 2006). One of the purposes of BOJ's policy seems to be to influence stock prices, although BOJ has not admitted to this purpose. The governor of BOJ has reiterated again and again the importance of increasing the transfer of funds from "safe" to "risky" assets. The quantitative easing policy is related to this purpose. This paper analyzes the relationship between Japanese stock prices and macroeconomic factors. In most developed countries, the most important factor in determining stock prices has been interest rates. However, in Japan, interest rates have been close to zero since the quantitative easing policy was implemented in 2001. The effect of interest rates changes on stock prices seems to have decreased to the point of being negligible. Other macroeconomic factors, such as exchange rates and U.S. stock prices, may affect stock prices. This paper finds that exchange rates and U.S. stock prices have been significant determinants of Japanese stock prices. [FIGURE 1 OMITTED] This paper is structured as follows. The next section provides a theoretical exploration of the relationship between the stock market and other macroeconomic factors. Empirical analysis is followed by the theoretical analysis. Finally, the paper concludes with a brief summary. II. RELATIONSHIP BETWEEN STOCK MARKET AND MACROECONOMIC FACTORS The relationship between stock prices and macroeconomic factors has been discussed all over the world. This paper considers the determinants of 'daily' stock prices in Japan. Daily stock prices are determined by many factors, including enterprise performance, dividends, stock prices of other countries, gross domestic product (GDP), exchange rates, interest rates, current account, money supply, employment, their information and so on. Countless factors have an impact on daily stock prices. It should be also noted that previous studies have used monthly or quarterly data whereas this paper relies on daily data. The factors that influence stock prices change over time. For example, in the 1970s and early 1980s, inflation rates were high, which in turn affected stock prices. However, that inflation rate has been stable since then. In general, since that time, interest rates have continued to have much influence on stock prices. Many studies have investigated the relationship between stock prices and interest rates. Campbell (1987); Cutler, Poterba, and Summers (1989); and Hodrick (1992) showed that short- and long-term interest rates have a modest degree of forecasting power for excess stock returns. Similarly, other studies, such as Campbell and Shiller (1991) and Fama (1984), have shown that the slope of the term structure of interest rates helps to forecast excess stock returns. …