DP2013-12

The Effect of Unconventional Monetary
Policy on the Macro Econom y:
Evid ence from Japan's Quantitative Easing
Policy Period
Masahiko SHIBAMOTO
Minoru TACHIBANA
April 2, 2013

The E e t of Un onventional Monetary Poli y on the Ma ro
E onomy: Eviden e from Japan's Quantitative Easing Poli y
PeriodyMasahiko Shibamoto

Minoru Ta hibanaz

April 2, 2013

Abstra t
This paper assesses the e e tiveness of un onventional monetary poli y on the ma ro e onomy. It fo uses on the Japanese e onomy during the Bank of Japan's quantitative easingpoli y period, and analyzes the e e ts of monetary poli y sho ks and systemati monetarypoli y using the ve tor autoregression model with simultaneous intera tion between sto k
pri es and poli y de isions. The main nding is that un onventional monetary poli y has asigni ant e e t on the ma ro e onomy, whi h is losely in line with the existing eviden e
under the onventional monetary poli y setting. The output e e ts work through thetransmission linking the sto k market and the real e onomy, while it plays a limited rolein terms of the pri e e e ts. The analysis also suggests that the Bank of Japan's systemati poli y responses mitigate severe downward pressure on the real e onomy generated
from the sto k market.
JEL Classi ation: E52; E58.
Keywords: un onventional monetary poli y; ve tor autoregression model; intera tion be-

tween monetary poli y and sto k market; e e ts of monetary poli y sho ks; systemati
monetary poli y responses.

We are grateful to Yuzo Honda, Takeo Hoshi, Toshiki Jinushi, Takashi Kamihigashi, Yoi hi Matsubayashi,
and Ryuzo Miyao for their helpful omments and suggestions. We also a knowledge the nan ial support froma Grant-in-Aid from the Japanese Ministry of Edu ation and the Zengin Foundation for Studies on E onomi s
andy Finan e.
Resear h Institute for E onomi s and Business Administration, Kobe University, 2{1, Rokkodai, Nada,
Kobe,
657{8501, Japan. E{mail: shibamotorieb.kobe-u.a .jp.
z S hool of E onomi s, Osaka Prefe ture University, 1-1, Gakuen{ ho, Naka{ku, Sakai, 599{8531, Japan.
E{mail: mta hie o.osakafu-u.a .jp.
1

1 Introdu tion

Un onventional monetary poli y is the poli y adopted by entral banks when the overnightinterest rate uts, onventionally ondu ted as the way of monetary poli y stimulus, are nolonger feasible due to its zero bound. Bernanke and Reinhart (2004), Bernanke, Reinhart, andSa k (2004) among others, divide un onventional monetary poli y tools into three ategories:(i) ommitment to future poli y stan e, (ii) quantitative easing, and (iii) redit easing, andhara terize un onventional monetary poli y as a ombination of these poli y tools. As argued
by Wright (2012), measuring the overall stan e of un onventional monetary poli y in thisenvironment is in itself not a straightforward task unlike the onventional monetary poli ysetting, under whi h the short term interest rate, i.e., the federal funds rate for the U.S. andthe un ollateralized overnight all market rate for Japan, provides a measure of the stan e.
One of novel features in this study is to fo us on the Japanese e onomy between Mar h2001 and Mar h 2006. There is a validity that we onsider the quantity of bank reserves,
i.e., the urrent a ount balan es (CABs), held at the Bank of Japan (BOJ) as a measureof the overall stan e of un onventional monetary poli y in Japan during that period. On 19
Mar h 2001, the BOJ adopted an un onventional monetary poli y that was oÆ ially referred
to as the \quantitative easing poli y (QEP)". The BOJ set the all rate at the zero lower
bound and shifted the instrument of monetary poli y from the poli y rate to the CABs. The
BOJ ontinued to inje t ample liquidity into the CABs beyond the level needed to maintainthe all rate at zero, and terminated ve years of its poli y on 9 Mar h 2006. During the
QEP period, the BOJ publi ly announ ed the target level of the CABs soon after every
Monetary Poli y Meeting (MPM) day, and the market parti ipants paid attention to thesepoli y announ ements.
Most ountries adopting an un onventional monetary poli y have fa ed e onomi downturn
generated by the sto k market. Japan was onfronted by a harsh e onomi and nan ial
situation at the time of introdu tion of the QEP. The Japanese e onomy in the early 2000s
su ered de reasing sto k pri es, de ationary pressures, and a signi ant fall in e onomi
1

The BOJ ontrolled the amount of funds in the money market through various tools of poli y operation,
in luding poli y ommitment, the supply of money and the pur hase of risky assets, to a hieve its target CAB
level. See Shiratsuka (2010) for the details.
12

a tivity due to the ollapse of the global IT bubble. This fa t is omparable to a ommon
feature in business y les, nan ial market dynami s, and the monetary poli y ondu t ofseveral advan ed ountries after the ollapse of Lehman Brothers in September 2008 provided
by Gamba orta, Hofmann, and Peersman (2012).
This paper proposes using a stru tural ve tor autoregressive (VAR) model with simultaneous intera tion between sto k pri es and poli y de isions to measure the e e ts of monetarypoli y sho ks and systemati monetary poli y during Japan's QEP period. Essentially, weneed to identify the poli y-indu ed hanges as monetary poli y sho ks in the VAR model andthe systemati poli y hanges from the total hanges in the CABs to assess the ausal e e ts
of monetary poli y. In addition, there is an interdependent relation between sto k pri es andmonetary poli y. As argued by a growing literature on the e e t of un onventional monetarypoli y on nan ial markets, in luding Gagnon, Raskin, Rema he, and Sa k (2011), D'Ami oand King (2013), Krishnamurthy and Vissing-Jorgensen (2011), Joy e, Lasaosa, Stevens, andTong (2011) and Wright (2012), the aggressive expansion of un onventional monetary poli yseems to a e t the sto k market. On the other hand, monetary poli y exerts a onsiderable
in uen e on sto k market. In this environment, failing to take into a ount the simultaneousintera tion between sto k pri es and poli y de isions ould seriously bias estimates of the
sto k market response to monetary poli y and monetary poli y rea tion to the sto k market.
It seems pe uliar that ompared with extensive resear h e orts on the nan ial market effe ts of un onventional monetary poli y, there exists only a small body of empiri al literature
quantifying its e e ts on the ma ro e onomy. Chung, Laforte, Reifs hneider, and Williams(2012) and Chen, Curdia, and Ferrero (2012) use the stru tural ma roe onomi model toondu t ounterfa tual simulations of how the e onomy would have performed in the absen e of the a tions of entral banks. However, they rely on models overing the pre- risis
2

3

4

As argued by Rigobon and Sa k (2003, 2004), even if the entral bank is not targeting sto k market pri es,
movements in the sto k market may importantly a e t monetary poli y de isions be ause the entral banksystemati ally responds to sto k market movements to the extent warranted by their impa t on future output
and3 pri es.
Bjrnland and Leitemo (2009) emphasize the need to allow for ontemporaneous intera tion between themonetary poli y settings and the determination of sto k pri es in the ontext of onventional monetary poli ysho4 ks.
Chung, Laforte, Reifs hneider, and Williams (2012) and Chen, Curdia, and Ferrero (2012) arry out
simulations using FRB/US ma roe onomi model and the medium-sized DSGE model, and argue that thepoli y a tions at that time mitigated severe e onomi re essions and de ationary risks.
23period, whi h may not be adequate for assessing ma roe onomi dynami s and monetarytransmission at the zero lower bound. Also, as a riti ism of these models by Sims (1980),
the many over-identifying restri tions of the stru tural ma roe onomi model may be boththeoreti ally and empiri ally suspe t, espe ially under the un onventional monetary poli ysetting. Baumeister and Benati (2012) and Kapetanios, Mumtaz, Stevens, and Theodoridis(2012) estimate a time-varying parameter stru tural VAR to investigate the ma roe onomi
impa t of un onventional monetary poli y sho ks. However, they impose sign restri tions,
namely the output and pri es do not de line in response to a ommodative monetary poli y
sho ks. An
restri tion on output and pri es aimed at eliminating the possibilityof ine e tiveness on the real e onomy would be inappropriate for our purpose, whi h is toassess the e e tiveness of un onventional monetary poli y in prote ting the ma ro e onomy
from e onomi re essions and a de ationary pressure. Gamba orta, Hofmann, and Peersman(2012) estimate a panel VAR from eight advan ed ountries, in luding Japan, over a sample
spanning the period sin e the onset of the re ent global nan ial risis. The motivation behind the identi ation strategy under their empiri al framework is quite similar to ours in thesense that they only use the sample period where the entral banks ondu t the un onventional monetary poli y, and rigorously disentangle exogenous monetary poli y shifts and theendogenous rea tion of entral bank from the global nan ial risis. However, it might not
be lear whether exogenous expansions in entral bank balan e sheets an be interpreted as
total un onventional monetary poli y sho ks given that poli y makers in luding the Fed, the
ECB, and the BOJ have emphasized poli y implementation ombining un onventional monetary poli y tools sin e the global nan ial risis. We strongly believe that the assessmentof whether Japanese un onventional monetary poli y during the QEP period was e e tive on
ma roe onomi onditions will serve as a useful guide for entral banks not only in Japan but
5a priori

6

7

Baumeister and Benati (2012) and Kapetanios, Mumtaz, Stevens, and Theodoridis (2012) identify narrowing long-short spreads of government bonds as the un onventional monetary poli y sho ks, whi h rely on
the empiri al eviden es in Gagnon, Raskin, Rema he, and Sa k (2011), D'Ami o and King (2013) and Joy e,
Lasaosa,
Stevens, and Tong (2011).
6
Gamba orta, Hofmann, and Peersman (2012) identify the un onventional monetary poli y sho ks by imposing a mixture of zero and sign restri tions su h that an exogenous in rease in entral bank balan e sheetsat the zero lower bound has ontemporaneously no impa t on output and pri es, and immediately mitigatesnanial market un ertainty measured by VIX.
7
For example, Chairman Bernanke expli itly denied that the Fed's rst planned program of asset pur hases
onstituted QEP (Bernanke, 2009). See also subse tion 2.1 for the BOJ and Tri het (2009) for the ECB.
54

also in other advan ed ountries in their ondu tion of un onventional monetary poli y.
There are two empiri al questions we fo us on in this paper. The rst is to examine
whether there exists a monetary poli y transmission linking the sto k market and the real
e onomy. A ording to previous literature on the e e t of un onventional monetary poli yon nan ial markets in Japan, the onsensus view is that Japanese un onventional monetarypoli y during the QEP period had a signi ant impa t on nan ial markets. However, it is
not lear whether this poli y aimed to in uen e ma roe onomi onditions. Honda, Kuroki,
and Ta hibana (2007) argue that an expansion of entral bank balan e sheets at the zero lower
bound has a positive e e t on not only the sto k market but also the ma ro e onomy, but
Kimura, Kobayashi, Muranaga, and Ugai (2003), Fujiwara (2006), and Nakajima, Kasuya,
and Watanabe (2011) report eviden e against this. While these studies do not expli itly
investigate the e e tiveness of the transmission e e ts linking the sto k market and the real
e onomy, we quantitatively measure them within the VAR framework.
Se ond, we investigate the role of systemati monetary poli y during the QEP period.
Although it is an important task to measure the e e ts of monetary poli y sho ks under a zeropoli y interest rate environment, a substantial part of the observed movement in CABs might
be explained by ma roe onomi onditions, given the BOJ's poli y obje tive of ma roe onomi
stabilization. Espe ially in the early 2000s, a sharp de line in sto k pri es ould ause the
CABs to rise. This systemati poli y rea tion might play a riti al role in avoiding a further
8

9

10

Ueda (2012) examine the daily responses of asset pri es to the BOJ's poli y hanges sin e Mar h 2001
motivated by the empiri al literature of Gagnon, Raskin, Rema he, and Sa k (2011), D'Ami o and King (2013),
Krishnamurthy and Vissing-Jorgensen (2011), and Joy e, Lasaosa, Stevens, and Tong (2011), and nd thatthe e e ts of the BOJ's un onventional monetary poli y measures on asset pri es have been broadly similar
between Japan and the advan ed ountries. Okina and Shiratsuka (2004) and Oda and Ueda (2007) reportthat the QEP, whi h ommitted itself to the a tual performan e of the CPI, had a signi ant e e t on lowering
the9yield urve.
Shirakawa (2010) mentioned the QEP e e ts on aggregate demand and pri es as follows:
Empiri al studies on Japan mostly show that quantitative easing produ ed signi ant e e ts onstabilizing the nan ial system, while it had limited e e ts on stimulating e onomi a tivity andpri es.
Ugai (2007) also on ludes in his omprehensive survey of empiri al studies of the e e ts of the QEP that theQEP'se e ts in raising aggregate demand and pri es were not dete ted or were small.
10
A lot of empiri al studies regarding the e e ts of monetary poli y, e.g., Bernanke, Gertler, and Watson(1997), Christiano, Ei henbaum, and Evans (1999), and Sims and Zha (2006), nd that identi ed monetarypoli y sho ks are a minor sour e of e onomi u tuations, and most of the observed movement in the instruments of monetary poli y is endogenous. In fa t, our identi ed un onventional monetary poli y sho ks insubse tion 4.3 explain less than 20% of the overall variation in output and pri es.
85severe e onomi re ession. In order to understand the role of systemati monetary poli yresponses, we ondu t a ounterfa tual simulation of what would have happened to the ma ro
e onomy in the absen e of the BOJ's a tions in the fa e of sto k pri e sho ks.
The main result that emerges from the empiri al analysis is that the un onventional monetary poli y during Japan's QEP period had a signi ant e e t on the ma ro e onomy, whi h
is losely in line with the existing eviden e under the onventional monetary poli y setting.
The output e e ts work through the transmission linking the sto k market and the real e onomy, while it plays limited role in terms of pri e e e ts. Counterfa tual simulation suggeststhat the BOJ's systemati poli y responses mitigate severe downward pressure on the real
e onomy generated by the sto k market.
The remainder of the paper is organized as follows. In Se tion 2, we o er the overview of
the BOJ's QEP and the Japanese e onomy between 2001 and 2006. In Se tion 3, we des ribe
our empiri al model. In Se tion 4, we report our ben hmark empiri al results. In Se tion 5,
we report empiri al results from alternative spe i ations to examine the robustness of ourben hmark results. In Se tion 6, we provide some impli ations from our empiri al results.
Se tion 7 on ludes the paper. Data Appendix des ribes the data we use in this paper.
2 Overview of the BOJ's QEP and Japanese E onomy from2001 to 2006

In se tion 2.1, we o er an overview of the QEP implemented from 2001 to 2006 and thendis uss what is the best indi ator of monetary poli y and why our analysis fo uses on the2001{2006 period. In se tion 2.2, we des ribe the Japanese e onomi situation at that timeand point out the potential problems asso iated with the empiri al analysis.
2.1 Chara teristi s of the BOJ's 2001{2006 QEP

The BOJ adopted its QEP in Mar h 2001 under severe e onomi ir umstan es that had begun
with the ollapse of the asset pri e bubble in the early 1990s and had been aggravated by the6ollapse of the global IT bubble in 2000. As explained in Ugai (2007) and Shiratsuka (2010),
the QEP during the 2001{2006 period onsisted mainly of three pillars: (i) the BOJ hanged
its main operating target for money market operations from the un ollateralized overnight all
rate to the outstanding urrent a ount balan es (CABs) held by nan ial institutions at
the BOJ. (ii) The BOJ made a ommitment that the QEP would ontinue until the onsumer
pri e index (ex luding perishables, the ore CPI hereafter) in ation be ame stably zero or
above. (iii) To smoothly a hieve the CAB target, the BOJ gradually in reased its outright
pur hases of long-term Japanese government bonds.
It is natural to onsider the CABs as the best indi ator of the BOJ's poli y stan e during the QEP period, and hen e we in lude the CABs, instead of the all rate, in our VAR
framework as a monetary poli y instrument. Table 1 des ribes the CAB targets de ided by
the Poli y Board of the BOJ at the MPMs, and Figure 1 plots the a tual amount of the
CABs along with the CAB targets and the all rate. The BOJ progressively raised the CAB
target in response to the deterioration of the e onomy (also see Figure 2 for movements of
ma roe onomi and sto k pri e variables in the QEP period). The a tual amount of the CABs
also in reased in line with in reases in the CAB target. Sometimes the BOJ provided ample
liquidity ex eeding the eiling of the CAB target when it deemed that nan ial institutions
fa ed a shortage of liquidity, for example, at the end and midway point of the s al year. On
the other hand, the all rate was kept at virtually zero per ent, meaning that it ontains noadditional information about the BOJ's poli y stan e during the QEP period.
Our analysis fo uses on the 2001{2006 period, not extending the estimation period tore ent years, sin e the BOJ hanged its operating target after the termination of the QEP.
When terminating the QEP in Mar h 2006, the BOJ restored its operating target to the allrate again. And then in O tober 2010, the BOJ adopted a new QEP alled \a omprehensive
monetary easing poli y" in the fa e of e onomi downturn aused by the world nan ial risis
in 2008. Under this new poli y regime, the BOJ did not adopt the CABs as its operating
11

12

13

11
Before adopting the QEP, the BOJ implemented the zero interest rate poli y from February 1999 to August
2000.
12
The all rate is an interbank overnight rate in Japan like the federal funds rate in the US. Miyao (2002)
on ludes that the all rate an be regarded as the best indi ator of monetary poli y in Japan for his estimation
period1975{1998.
13
See Ugai (2007) and Shiratsuka (2010) for more detailed explanation about the BOJ's 2001{2006 QEP.

7

target. Instead, the BOJ established a new fund to pur hase several types of nan ial assets,
and it in reased the total size of the fund when pursuing further monetary easing. Therefore,
if the CABs were used as the monetary poli y indi ator with the sample period in luding thepost-2006, then sho ks to the CABs identi ed by the VAR analysis might not be interpreted
as monetary poli y sho ks.
2.2 Japanese E onomy during the QEP Period

Figure 2 shows the time series of real output, goods pri e, and sto k pri e as well as the CABs
from the early 2000s to 2006. We use the index of industrial produ tion (IIP) as a proxy ofreal output, the ore CPI as a proxy of goods pri es, and the Nikkei 225 average index as aproxy of sto k pri es.
In the rst half of the period, output, goods pri es, and sto k pri es were severely de lining
due, in part, to the burst of the global IT bubble. In response to this rapid deterioration of thee onomy, the BOJ in reased its provision of liquidity to the CABs. From mid-2003, output
and sto k pri es began gradually in reasing, while the ore CPI stopped de lining temporarily
but it began to de line again from 2005.
There are three points we should take note of in Figure 2 before formally analyzing thee e t of the QEP. First, the gure shows a negative orrelation between ma roe onomi andsto k pri e variables and the CABs in the early phase of the QEP. One interpretation of thenegative relationship is that the QEP had no e e t on the Japanese e onomy. The otherinterpretation is that the QEP ould not reverse the de line of the e onomy but was at least
able to mitigate that de line. To see whi h hypothesis is true, we ondu t a ounterfa tualanalysis in subse tion 4.4, in whi h we examine what would have happened if the BOJ had
not in reased the CABs in response to the e onomi downturn.
Se ond, it is also seen from the gure that the IIP and sto k pri es have been positively
orrelated with the CABs sin e the mid-2003. The Japanese e onomi re overy re e ted in
the IIP and sto k pri es may be attributable not only to the in uen e of the QEP but toother ma roe onomi fa tors in luding the improvement of the nan ial situation and theresolution of the non-performing loan problems following the nationalization of the Resona
8Bank (May 2003), or to the in rease in exports during the period. Therefore, in se tion 5,
in whi h several robustness analyses are ondu ted, we estimate the VAR spe i ations that
ontrol for the latter two possible e e ts.
Third, ea h of the variables in the gure an be regarded as following a unit root pro ess.
Thus we use the growth rate of sto k pri es and the CABs in the ben hmark model while the
IIP and the CPI remain in level. Further, in se tion 5 we estimate an alternative spe i ation
with the rst log di eren e of the IIP and the CPI.
3 E onometri Framework

This se tion des ribes the e onometri framework employed in this paper. The framework
follows that of previous studies in that it ombines high-frequen y nan ial market data withmonthly VARs to a hieve identi ation, su h as in Co hrane and Piazzesi (2002), Faust,
Swanson, and Wright (2004), and D'Ami o and Farka (2011). In parti ular, the idea of ouridenti ation is similar to one developed by D'Ami o and Farka (2011). We rst run a highfrequen y regression of sto k returns on poli y sho ks outside the VAR to obtain the sto kmarket response to poli y a tions, and then, in the se ond step, estimate the monetary poli yrea tion to sto k pri es by dire tly imposing the rst-step estimate in the monthly VAR.
By doing so, we isolate the nan ial markets response to monetary poli y and the monetarypoli y rea tion to nan ial markets, and assess the e e tiveness of un onventional monetarypoli y in Japan from the viewpoint of the real e onomi e e ts of not only monetary poli y
sho ks but also systemati monetary poli y.
However, we annot dire tly follow the D'Ami o and Farka's (2011) te hnique to analyze
the un onventional monetary poli y. In ontrast with the analysis under the onventionalmonetary poli y setting, we annot dire tly measure surprise hanges in the CABs as a proxyof the un onventional monetary poli y stan es during Japan's QEP period be ause there isno market-based proxy to gauge the poli y expe tations on the target level of the CABs.
14

As in Kuttner (2001), among others, D'Ami o and Farka (2011) use the hanges in the urrent monthfederal funds futures rate in a narrow window around FOMC announ ements as a dire t measure of monetarypoli y sho ks under the onventional monetary poli y setting, and run the ordinary least squares regression ofhanges in sto k pri e futures on poli y sho ks to estimate the sto k market response to poli y a tions.
149

So, as in Wright (2012), we employ the methodology of Rigobon and Sa k (2004) tomeasure the sto k market responses to monetary poli y sho ks with a daily frequen y. Thisis an identi ation strategy using heteros edasti ity in daily-frequen y data under whi h weassume that the varian e of monetary poli y sho ks is higher on days of monetary poli yboard meetings when a larger portion of the news hitting markets is about monetary poli y.
One of novel features of our e onometri framework unlike the previous VAR studies, su h
as Christiano, Ei henbaum, and Evans (1999) and Honda, Kuroki, and Ta hibana (2007),is that identi ation does not depend on the restri tion that the entral bank endogenously
and ontemporaneously responds to nan ial markets. We show that we should take intoa ount the interdependen e between sto k market and monetary poli y de isions to isolate
the nan ial markets' response to monetary poli y and the monetary poli y rea tion to nanial markets, and dis uss its importan e when we assess the e e tiveness of un onventionalmonetary poli y in the following se tion reporting our empiri al results.
15

3.1 VAR model
Xt is given by (Yt0 ; SRt ; CABt )0 , where Yt is a ve tor of n

2 ma roe onomi variables, andSRt and CABt denote sto k returns and the hanges of the CABs as a proxy of the BOJ's
behavior during the QEP period as des ribed in the previous se tion, respe tively. Suppose
the e onomy is des ribed by a following stru tural form VAR:
A0 Xt = A(L)Xt + t ;(1)

and its redu ed form ounterpart Xt = (L)Xt + ut , where A(L); (L) are matrix polynomials
0 MP 0 0
in lag operator L, t = (yt 0 ; SRt ; t ) is an (n  1) ve tor of zero-mean stru tural sho ks
with diagonal varian e- ovarian e matrix D, ut = Rt is a ve tor of redu ed form innovations, the diagonal elements of A are equal to one, and R = A . Note that the matrix of001

As shown by Rigobon and Sa k (2004), the estimators under heteros edasti ity are generalized to ones
under an event-study approa h, whi h is applied by Gagnon, Raskin, Rema he, and Sa k (2011), D'Ami o andKing (2013), Krishnamurthy and Vissing-Jorgensen (2011), Joy e, Lasaosa, Stevens, and Tong (2011), andUeda (2012) to examine the daily nan ial market responses to un onventional monetary poli y.
15

10ontemporaneous oeÆ ients A of the form:
0

3
2
m
m
A
A
A =6
4 fM fF 75 :
0

0

(2)

0

A0M A0F

We assume that ma roe onomi variables su h as output and pri es respond with lag
to poli y a tions and sto k pri e sho ks. This assumption is re e ted by AmF = 0. This
assumption is ommon in the VAR literatures, for e.g., Christiano, Ei henbaum, and Evans(1999), among others.
We allow for simultaneous responses between
0 CAB 1and SR. In other words, suppose
1
C
that the AfF blo k an be written as AfF = B
A be ause the diagonoal elements1of A are equal to 1; then we do not impose the restri tion of either no instantaneous impa t
of monetary poli y, = 0, or no ontemporaneous monetary poli y rea tion to sto k returns,= 0, to identify the system.
0

0

0

0

3.2 Instantaneous impa ts of monetary poli y on sto k returns

We think of stru tural sho ks t as umulative sho ks in daily series over the ourse of amonth t = PDd t;d , where d indexes the days within the month. We assume that thesame relationship between stru tural and redu ed form errors applies at high-frequen y as it
does in monthly data. Under this assumption, we represent the ontemporaneous relationshipbetween SRt;d and CABt;d at the time t; d as follows;=1

SRt;d =

CABt;d + yt;d + SRt;dCABt;d = SRt;d + Æyt;d + MP
t;d :

(3)
(4)

Equation (3) is the sto k pri e equation at a daily frequen y, whi h allows the SR to bea e ted by the CAB s and also by the other ma roe onomi sho ks (news) yt;d. Equation(4) represents a monetary poli y rea tion fun tion at the daily frequen y that aptures theexpe ted response of poli y to the SR and yt;d .
As seen from equations (3) and (4), we annot ne essarily obtain a onsistent estimate of11the impa ts of monetary poli y on sto k returns using ordinary least square (OLS) due tothe presen e of both endogeneity and omitted variable bias. In parti ular, if we regress (3)by the OLS, the estimate would be biased below its true value in ases where the entral
banks ounter y li ally responds to sto k returns, whi h imply a negative relation between
the CABs and sto k returns ( < 0).
In order to estimate the impa t of monetary poli y on sto k returns , we follow themethodology introdu ed by Rigobon and Sa k (2004). Their idea is to look at hanges in theo-movements of monetary poli y measures and asset pri es when the varian e of one of the
sho ks in the system is known to shift. They use the institutional knowledge of the entral
bank to separate the sample period into two subsamples, P D and NP D. Spe i ally, days ofthe poli y announ ement are likely to ontain a greater amount of news about monetary poli ythan other days, although other sho ks still take pla e on these days. Following Rigobon and
Sa k (2004), we take those dates as the set of dates P D, or poli y dates, to indi ate that thevarian e of the poli y sho k is elevated. For the set of non-poli y dates NP D, we take the setof days immediately pre eding those in luded in subsample P D, whi h minimizes any e e ts
arising from hanges in the varian es of the sho ks over time.
The identifying assumption is that the varian e of the poli y sho ks in reases in subsample
P D, while the sto k pri e sho ks and the other sho ks are assumed to o ur with the same
intensity as in subsample NP D. Let P D and NP D denote the varian e- ovarian e matri esof the variables, SRt;d ; CABt;d, on the subsamples, P D and NP D, respe tively. Under theabove identi ation assumption, we obtain16

 = PD

2PD
NP D ) 6(MPMPNP D =(1 ) 4
2

2

1

3
75 ;

(5)

P D and  NP D represent the varian es of monetary poli y sho ks in subsamples
where MPMP
P D and NP D, respe tively. As is evident from equation (5), two parameters, and  

In fa t, we an obtain a onsistent estimate of only if CABt;d is predetermined when 2sto k pri e andother ma roe onomi sho ks o 2ur ( = 0; Æ = 0), or the varian e of monetarypoli 2y sho ks, 2MP , is2 in nitly
2larger than sto k pri e sho ks, SR , and other ma roe onomi sho ks, y2 (MP=SR ! 1; MP =y ! 1).
See Rigobon and Sa k (2004) for details.
1612

, an be identi ed from three restri tions on the hange in the ovarian e matrix.
In pra ti e, we implement the Generalized Method of Moments (GMM) approa h to estimate . In order to he k the validity of the identi ation assumption that we have imposedon the model, we use a standard Sargan statisti s to test whether the over-identifying restri tions for the equation (5) are satis ed or not.
We ompare the estimates under a heteros edasti ity-based approa h ^het to the OLS
estimates ^OLS . Spe i ally, in order to test the null hypothesis that the OLS estimate ^OLS
is onsistent and eÆ ient, we use the following Hausman (1978) type test statisti s:


PD
( MP
(1

NP D )
MP

)2

17

j ^het ^OLS j[V ar(^het) V ar(^OLS )℄ j ^het ^OLS j;1(6)

whi h asymptoti ally follow the hi-square distribution with one degree of freedom under thenull hypothesis.
3.3 Contemporaneous monetary poli y rea tion to sto k returns

First, we dire tly impose the estimated oeÆ ient ^ from the high-frequen y regression in themonthly VAR. Next, we onsider the following system regression model:

2
64 1

32
^ 76
54

1

SRt

CABt

3
3
2
SR
75 = AfY Yt + Af (L)Xt + 64 t 75 :
MP
0

t

(7)

We an estimate the ontemporaneous poli y responses to a sto k pri e sho k under system(7) by onsidering the interdependent relation between the sto k market and monetary poli y.
Let ^SRt denote the residuals from the rst regression in equation (7). We estimate the se ond
regression by regressing the monetary poli y variable, CABt, on ontemporaneous andlagged values of all variables, using residuals ^SRt as an instrument for SRt , and obtain theestimate of the parameter on CABt, ^. In this way, we an omplete the identi ation of
the monthly VAR system.
Rigobon and Sa k (2004) suggest two di erent approa hes to estimate ; one implemented the instrumental
variables regression by using wm  [CAB P D CAB NP D ℄ as the instruments and the other implemented itusing the GMM appra h. We also implement the instrument variables regression and obtain the similar results
as the following ben hmark ones.
17

13

4 Ben hmark Results

This se tion provides the empiri al results using our e onometri framework. First, we estimate the instantaneous impa t of monetary poli y sho ks on sto k returns using theassumption that monetary poli y sho ks have espe ially high varian e on days of poli y announ ements, while there is nothing unusual about these days from the perspe tive of any
other sho ks to the e onomy. Se ond, we estimate the monetary poli y response to sto k
return . Third, we estimate the impulse responses of monetary poli y sho ks on output,
pri es, sto k pri es, and CABs to examine the dynami ausal e e ts of monetary poli y, andquantitatively measure the transmission e e ts linking the sto k market and real e onomy
within the VAR framework. Finally, we estimate the impulse responses of sto k pri e sho ks
to examine the in uen es of sto k pri es on the CABs and the ma ro e onomy and ondu t
the ounterfa tual simulation of what would have happened to the ma ro e onomy in theabsen e of systemati poli y a tions in the fa e of sto k pri e sho ks.
4.1 Instantaneous impa ts of un onventional monetary poli y on sto k returns

Table 2 reports the statisti s on daily hanges in CAB and in sto k returns. CAB andsto k returns are rst log di eren es of CABs and sto k pri es, respe tively, multiplyed by100. The rst to third olumns of Table 2 indi ate the standard deviation of asset pri es using
full samples, non poli y dates, and poli y dates, respe tively. The fourth to sixth olumnsof Table 2 indi ate the ovarian e with the CAB using full sample, non poli y dates, andpoli y dates, respe tively.
In Table 2, we nd that the standard deviation of CAB rises substantially on the days
with higher varian e of poli y sho ks, as expe ted. More importantly, a positive relationshipbetween these variables be omes evident on the poli y dates, as the higher varian e of thepoli y sho ks on those days tends to move the observations along the sto k pri e response
fun tion, whereas there is no lear relationship between sto k pri es and the CAB on fullsample and non-poli y dates, as eviden ed by the relatively small ovarian e between them.
Table 3 reports the estimates of the parameter on sto k returns for equation (3). The rst
14row in this table indi ates the estimate obtained using heteros edasti ity assumptions, ^het.
The se ond row indi ates the simple OLS estimate ^OLS = Cov(CAB; SR)=(std(CAB ) 
std(SR)) using the full sample. The third row indi ates a Sargan statisti s to test whether or
not the over-identifying restri tions for equation (5) are satis ed. The fourth row indi ates
a Hausman-type test statisti s to test the null hypothesis that the OLS estimate ^OLS is
onsistent and eÆ ient.
There are three empiri al ndings we should mention from Table 3. First, the entral
banks an have an impa t on sto k markets even under a zero short-term interest rate. In the
rst row of Table 3, we nd that the estimate under the heteros edasti ity-based approa h^het is positive and statisti ally signi ant. This means that the aggressive poli y-indu ed
rise of the CABs led to an in rease in sto k pri es immediately during the QE period. Thisis onsistent with the ndings in Ueda (2012).
Se ond, it is a plausible way to impose the heteros edasti ity assumptions to identify
the e e ts of monetary poli y sho ks at a zero short-term interest rate lower bound. In thethird row of Table 3, a Sargan statisti s indi ates that we annot reje t the over-identifying
restri tions of the model. This implies the validity of the identi ation assumption that wehave imposed on the model.
Third, interdependen e between sto k market and monetary poli y plays a riti al role inestimating the impa t of monetary poli y on sto k pri es. In the se ond row of Table 3, the
OLS estimate ^OLS is very small and statisti ally insigni ant. In the fourth row of Table 3,
a Hausman-type test statisti s shows that the null hypothesis that the OLS estimate ^OLS is
onsistent and eÆ ient is reje ted. This implies that the simple OLS estimates underestimate
the monetary poli y e e ts on sto k returns due to an endogenous and omitted variables bias.
4.2 Contemporaneous responses of un onventional monetary poli y to sto k
returns

In this subse tion, we examine the ontemporaneous responses of monetary poli y to sto k
returns. First, we estimate a 4-variable redu ed-form VAR model using monthly data. As aben hmark, we onsider the VAR model ontaining the logarithm of the IIP multiplied by 100
15as a proxy of output, the logarithm of ore CPI multiplied by 100 as a proxy of goods pri es,
the rst log di eren e of the Nikkei 225 index or TOPIX multiplied by 100 as a proxy of sto k
return, and the rst log di eren e of CABs multiplied by 100. We set the lag length to fourin the redu ed-form VAR estimation, whi h is suÆ ient to apture the system dynami s.
Next, we impose the estimate under the heteros edasti ity-based approa h ^het into equation(7) and estimate the ontemporaneous monetary poli y rea tion to sto k returns . Table
4 shows the estimate of poli y rea tion to sto k returns ^ when we impose the estimate ofontemporaneous sto k returns e e ts of monetary poli y sho ks ^het = 0:16.
The entral bank endogenously and simultaneously responds to the sto k market. In Table
4, we nd that the estimate ^ is negative and statisti ally signi ant. This means that the
BOJ took immediate a ommodative poli y stan es in response to severe downward pressure
on the sto k market during the QE period.
The result in Table 4 also implies that we reje t the usual assumption that the entral
bank does not respond to the nan ial market movements ontemporaneously ( = 0). This
assumption, whi h is imposed by a large VAR literature in luding Christiano, Ei henbaum,and Evans (1999), Honda, Kuroki, and Ta hibana (2007) to analyze the monetary poli y,ignores, at least in part, the in uen es of the a tual systemati poli y a tions to stabilize thema roe onomi onditions.
18

4.3 Dynami

ausal e e ts of un onventional monetary poli y

We rst highlight the impulse responses to a monetary poli y sho k. Figure 3 displays theimpulse responses for all the variables with respe t to one standard error monetary poli y
sho k for a period of up to 48 months. The solid lines represent the point estimates of
the responses, and shaded areas represent 16th and 84th per entile error bands al ulatedby the bias-adjusted bootstrap method proposed by Kilian (1998) with 10000 repli ations.
The responses for the SR and the CAB are displayed as the ummulative responses, whi h19

18
We perform a modi ed likelihood ratio test proposed Sims (1980) to he k whether taking four lags
is suÆ ient. Here the null of four lags is tested against the alternative of six lags or ten lags. The hisquare statisti s indi ate that the null is not reje ted by onventional signi an e levels for ea h of the models
onsidered.
19
We only report the results using Nikkei 225 average as a proxy of sto k pri e. In using TOPIX, we obtainnearly the same results as the ben hmark.

16

re e t the responses in levels.
The impulse response patterns for a monetary poli y sho k are losely in line with theexisting eviden e under the onventional monetary poli y setting. The left upper hart in
Figure 3 indi ates that output rises for one year or so up to an expanding monetary poli y sho k, whi h is statisti ally signi ant, and then goes ba k to steady state level. The
maximum estimated positive e e t in response to a one-standard-deviation monetary poli y
sho k is about 0.45, whi h is omparable with the monetary poli y e e t on output under
the onventional monetary poli y setting in Japan obtained by West (1993), Shioji (2000),
Miyao (2002) and Braun and Shioji (2006).
The right upper hart in Figure 3 indi atesthat the rises in ore CPI are also statisti ally signi ant for about two years after a poli y
sho k. Overall, monetary poli y sho ks had a signi ant e e t on the real e onomy during
Japan's QEP period. The left lower hart in Figure 3indi ates that the responses of sto k
returns jump initially above the steady state, and remain persistent. This suggests that themonetary transmission via sto k returns is operating to that degree. This nding is onsistent with the results under the onventional monetary poli y setting in Miyao (2002), andsupports the arguments of the e e tiveness of the un onventional monetary poli y throughthe sto k pri e hannel by Honda, Kuroki, and Ta hibana (2007). The left lower hart in
Figure 3 indi ates that the responses of CAB jump initially above the steady state, and then
20 21

22

West (1993), Shioji (2000), Miyao (2002) and Braun and Shioji (2006) all study the role of Japan's monetarypoli y with their sele ted poli y variable and identi ation framework. West (1993) adopts the nonre ursive
identi ation framework to Japan's innovations in the money supply (M2) equation as monetary poli y sho ks.
Shioji (2000) uses the nonre ursive identi ation framework with some monetary poli y variables (the Bankof Japan loan and high-powered money), and on ludes that a model based on the view that the entral bankontrols the total amount of high-powered money is better for des ribing Japanese monetary poli y than one
based on the view that it ontrols only a spe i omponent of high-powered money. Miyao (2002) argues thatthe institutional features of the Bank of Japan's operating pro edures under the onventional poli y setting t a
simple re ursive identi ation approa h similar to Sims (1992) and Christiano, Ei henbaum, and Evans (1999),
where disturban es in the short-term interest rate equation are viewed as the exogenous part of monetary poli yand the interest rate is pla ed before monetary aggregates in the ordering. Braun and Shioji (2006) use thetwo alternative sign restri tions where a surprise tightening in monetary poli y in reases short-term nominalinterest rate and lowers output, pri es, monetary aggregates on the one hand, and a surprise tightening inmonetary poli y lowers short-term nominal interest rate and lowers output, pri es, monetary aggregates on theother hand, and argue that under the latter assumption, monetary poli y has large and persistent e e ts on
the21e onomy.
This is also omparable with the eviden e in other ountries obtained by, e.g., Kim (1999), Christiano,
Ei22henbaum, and Evans (1999), and D'Ami o and Farka (2011).
The size of ore CPI responses to monetary poli y sho ks is quite small. One possible reason is its smallu tuation during the QEP period. In fa t, when we estimate the pri e e e ts of monetary poli y sho ks using
the CGPI as a proxy of pri es, the size is mu h larger than one using the ore CPI. See the empiri al results
in se tion 5.
20

17

go ba k to the steady state level in 6 months. This implies that the monetary poli y sho ks
have only transitory, not persistent, e e ts on the level of CABs.
Next, we measure the quantitative e e ts of the QEP worked through the transmission
linking the sto k market and the real e onomy. Spe i ally, we al ulate the e e ts of themonetary poli y sho ks identi ed from the restri ted VAR model in whi h we in lude thesto k returns SR as an exogenous variable. This exer ise re e ts a ase where sto k returns
do not respond to monetary poli y sho ks endogenously, that is, a ase of the shut down of theimpa ts on the sto k returns. Then, we ompare the ben hmark ones with the ones obtained
from this exer ise.
Figure 4 shows a omparison of the impulse responses to a one-standard-deviation monetary poli y sho k for di erent VAR spe i ations. The solid lines with + symbols in Figure
4 show the e e ts of the monetary poli y sho ks identi ed from the restri ted VAR model in
whi h sto k returns are in luded as an exogenous variable.
As seen in left upper hart of Figure 3, the output e e ts disappear in the absen e ofthe monetary poli y impa ts on sto k pri es. This implies that the sto k pri e hannel ana ount for a large portion of the QEP e e ts on output. Pri e responses are almost the sameas the ben hmark (the solid lines), whi h implies that the sto k pri e hannel plays limited
role in terms of the QEP e e ts on pri es.
Finally, we analyze the quantitative in uen es if we spe ify the VAR model in whi h we
impose an assumption that the entral bank does not respond to ontemporaneous sto k pri e
sho ks. Spe i ally, we ompare the ben hmark results with the e e ts of monetary poli y
sho ks identi ed based on the re ursive assumption, whi h is employed by VAR studies su has Honda, Kuroki, and Ta hibana (2007). The dotted lines in Figure 4 show the e e ts of thepoli y sho ks identi ed under the re ursive assumption.
Even if we in lude sto k returns in the VAR system as an endogenous variable, we would
obtain biased estimates of the QEP e e ts. The left upper hart in Figure 4 indi ates that theoutput impa t of the poli y sho ks identi ed under the re ursive assumption is about a half
smaller than the ben hmark, while the pri e response is almost the same as the ben hmark.
The sto k pri e responses are mu h smaller (immediate response is about 0:03) than the18ben hmark (immediate response is 2:20). These results imply that, when we ignore theontemporaneous poli y response to sto k pri e sho ks, we underestimate the monetary poli ye e ts on sto k returns and the real e onomy due to an endogenous variable bias.
4.4 Systemati un onventional monetary poli y responses to a sto k pri esho k

In this subse tion, we analyze the role of the systemati poli y a tions in response to sto k
pri e sho ks. We fo us primarily on sto k pri e sho ks for two reasons. First, there is aonsensus that a sharp de line of the sto k pri es espe ially in the early 2000s triggered ane onomi re ession and de ationary pressures and thus, at least in part, systemati ally aused
the CABs to rise. Se ond, we an rigorously identify sto k pri e sho ks in our e onometri
framework to the extent that we spe ify the simultaneous intera tion between sto k pri es
and poli y de isions. We rst estimate the impa ts of the sto k pri e sho k on ma roe onomi
variables. Se ond, we illustrate what would happen if the systemati omponent of monetarypoli y were di erent from the a tual poli y.
Figure 5 displays the impulse responses for all the variables with respe t to a negativeone-standard-deviation sto k pri e sho k for a period of up to 48 months, together with the16th and 84th per entile error bands. As in Figure 3, we display the responses for SR andCAB as the umulative responses.
The results of gure 5 look reasonable, with all variables exhibiting their expe ted qualitative behaviors. The upper harts in Figure 3 indi ate that a negative sho k to sto k returns
is followed by a fall in output for about one year or so, despite the limited impa t on thepri e. This implies that a sharp de line in sto k pri es leads to an e onomi re ession. The
right lower hart in Figure 3 indi ates that a negative sho k to sto k pri es is followed by astatisti ally signi ant rise in the CAB, as expe ted, and the response is permanent. Thisimplies that the BOJ systemati ally a ommodated a sharp de line in sto k pri es and eased
the monetary ondition permanently.
Next, we obtain a quantitative measure of the importan e of the systemati omponent ofmonetary poli y by omparing the histori al behavior of the e onomy with its behavior under19

a hypothesized alternative poli y rea tion fun tion. We employ ounterfa tual simulations
within the VAR framework suggested by Bernanke, Gertler, and Watson (1997) and Sims andZha (2006). Spe i ally, as a hypothesized alternative poli y rea tion fun tion, we onsider
a ase in whi h the monetary authority holds CAB xed in the fa e of sto k pri e sho ks.
In gure 5, we also show impulse responses for a system in whi h the model's estimatedmonetary poli y rea tion fun tion is repla ed by one in whi h CAB is ompletely unresponsive to other variables in the system (solid lines with + symbols). The di eren e between
the total e e t of a sto k pri e sho k on the system variables (the estimates under baselinemodel, solid lines) and the al ulated e e t when CAB is unresponsive is then interpreted
as a measure of the ontribution of the endogenous poli y response.
As seen in Figure 5, the absen e of an endogenous monetary poli y results in the larger
de line of the sto k pri es and Core CPI and more volatile output u tuations to a negative
sto k return sho k than the presen e of an endogenous poli y. This implies that, if themonetary authority rea ted to a sto k pri e sho k by holding CAB xed instead of, as it
did histori ally, expanding CAB to o set the downward pressure of the sto k pri es, the result
would be more depressing e e ts of the sho k on the ma ro e onomy.
The analysis also helps to reveal the BOJ's relative weight on output and in ation variability in its preferen es during the QEP period. Quantitatively, a systemati monetary poli ysuÆ es to eliminate most of the pri e e e t of a sto k pri e sho k. This suggests that the
BOJ strongly fo uses on in ation stabilization under the un onventional monetary poli y setting, whi h is onsistent with the ndings for the monetary poli y rea tion fun tion under theonventional monetary poli y setting in Japan by Clarida, Gali, and Gertler (1998), Jinushi,
Kuroki, and Miyao (2000), and Shibamoto (2008).
23

24

25

West (1993) also performs ounterfa tual simulations in a VAR ontext to examine the e e ts of systemati
monetarypoli y under several money supply rules.
24
In this exer ise, all other equations of the system are held xed, whi h implies that we are ignoring
hanges in the dynami s of the private se tor that would o ur as private agents modi ed their algorithms
for fore asting the e onomy under the new poli y. That is, we are ignoring the Lu as ritique. We thinkthat this is nonetheless an interesting exer ise, for pra ti al purposes probably even more interesting than anexer ise that takes into a ount the Lu as ritique via the unreasonable assumption that the poli y hange isimmediately
and fully understood and that the publi has no doubt that it is permanent.
25
Clarida, Gali, and Gertler (1998), Jinushi, Kuroki, and Miyao (2000), and Shibamoto (2008) estimate
the Taylor (1993) type monetary poli y rea tion fun tion, where the behavior of an overnight all market
interest rate as a monetary poli y instrument depends on the (expe ted) output gaps and (expe ted future)
in ation, and report that the BOJ has pla ed somewhat more weight on ontrolling in ation relative to output
23

20

5 Empiri al Results from Alternative Spe i ations

Be ause any empiri al analysis might have some tentativeness, it is important to examine
several alternative frameworks and he k robustness in some detail. In this se tion we reporton several robustness he ks arried out in order to evaluate the sensitivity of the empiri al
results reported in the previous se tion.
We re-estimated the instantaneous impa ts of monetary poli y on sto k returns to
examine the robustness of the estimates using the high-frequen y model. Spe i ally, we
onsider two alternative spe i ations for the high-frequen y model; (i) we allow for lags inequations (3) and (4) and perform the same analysis on the redu ed-form residuals; (ii) we
follow Wright (2012) and estimate the e e ts of monetary poli y sho ks on sto k returns
and the CABs by using the daily VAR model onsisting of the CABs, sto k return, anddi eren es between long-term and short-term interest rates whi h re e ts, to some extent,
the expe tation of the future monetary poli y stan e. These results are nearly identi al, andhen e we do not report them.
Next, we re-estimated the dynami e e ts of monetary poli y and sto k pri e sho ks to
he k the robustness of the ben hmark results using the VAR model. We modify the ben hmark VAR spe i ation to take into a ount four dimensions: (i) the hoi e of the measuresof output and pri e levels; (ii) the in uen es of the presen e of alternative ontributors to
the real e onomy; (ii) the possibility that identi ed monetary poli y sho ks are ontaminatedby a sudden rise in the CABs due to the liquidity demand of nan ial institutions; (iv) the
possibility of the misspe i ation of the ben hmark model due to the unit root pro ess of
output and pri es.
Tables 5 and 6 report some summary from alternative spe i ations of our VAR system.
Spe i ation [1℄ of tables 5 and 6 report results for the omposite index of oin ident e onomi
indi ators (CI) as a proxy of output, whereas spe i ation [2℄ report results for orporate goods
pri e index (CGPI) as a proxy of pri e level. Spe i ation [3℄ reports results from the modelin whi h we in lude the dummy variables as exogenous variables that take values of one fromMay 2003 onward where we he k whether our ben hmark results are in uen ed by otherstabilization.

21

ma roe onomi fa tors in luding, for example, the improvement of the nan ial ondition
and the resolution of the non-performing loan problems following the nationalization of theResona Bank. Spe i ation [4℄ reports results from the VAR model in whi h we in lude
the ommodity pri e index as an endogenous variable, where we follow Sims (1992) andChristiano, Ei henbaum, and Evans (1999) and in lude information about future in ationthat was available to the BOJ. Spe i ation [5℄ and [6℄ report results from the VAR modelin whi h we in lude the export volume as an endogenous variable and 1 to 4 lags of the IIP
in the US as an exogenous variable, respe tively, where we ontrol the exogenous in reases inthe values of exports due to strong overseas e onomi performan e. Spe i ation [7℄ reports
results from the model in whi h we in lude the dummy variables as exogenous variables thattake values of one on Mar h and September every year when the BOJ deemed that nan ial
institutions fa ed a shortage of liquidity. Spe i ation [8℄ reports results from the modelwith the rst log di eren e of IIP and Core CPI. Values in bold indi ate the point estimatessigni antly di erent from zero based on the bootstrapped on den e intervals in the samemanner as gures 3 and 5. Table 5 also shows the di eren es between the baseline spe i ationand the results obtained from the VAR model in whi h sto k returns are in luded as an
exogenous variable, whereas Table 6 shows the di eren es between the baseline spe i ationand the results obtained under the hypothesized poli y rea tion, in whi h the CAB is xed
at its baseline value. Values in bold indi ate that the on den e interval for the baseline
spe i ation do not ontain the e e ts obtained under the restri ted VAR model in whi h SR
is in luded as an exogenous variable in Table 5 and the ounterfa tual assumption in whi h
the CAB is held xed in Table 6.
The point estimates reported in table 5 are onsistent with the ndings dis ussed ingures 3 and 4. In parti ular, the baseline estimates show that a monetary poli y sho k raises
output, pri e level, and sto k pri es, by magnitudes that are reasonably omparable a rossall spe i ations. The di eren es in output e e ts are signi antly positive in all ases, whi h
implies the output e e ts of monetary poli y sho ks in the baseline are mu h larger thanin the ase of a shut down of the impa ts on the sto k returns, whereas the di eren es inpri e e e ts of monetary poli y sho ks are quite small. Again, as reported in Table 6, we see
22quantitatively similar results as the ndings dis ussed in gure 5. These results suggest thatour ben hmark model adequately aptures the important features regarding the e e ts of the
un onventional monetary poli y on the ma ro e onomy during Japan's QEP period.
We note some additional ndings from alternative spe i ations. First, there are large
di eren es in the pri e e e ts between ore CPI and CGPI. Spe i ation [2℄ in Table 5 indi ates that the size of CGPI responses are signi antly larger than that of the ore CPI in
the ben hmark. Spe i ation [3℄ in Table 5 also indi ates that the size of ComP responses
are signi antly larger than that of the ore CPI. This suggests that the QEP had a stronger
impa t on raw material, primary and intermediate goods pri es than on nal goods pri es.
Se ond, as shown in Spe i ation [5℄, expanding monetary poli y sho ks lead to a statisti allysigni ant rise in exports, whi h suggests that the QEP promoted exports. Third, with rst
di eren es spe i ation in Spe i ation [8℄, the estimated impulse responses of output andpri es to monetary poli y and sto k pri e sho ks are long-lasting. One reason is that wemight not impose possible o-integrated relations in our VAR system, whi h means that it
may not be a stationary VAR system. Therefore, it is desirable to estimate the ben hmark
VAR model in luding output and pri es in levels.
26

27

6 Dis ussion

In this se tion, we dis uss some impli ations from our analysis and the di eren es between
our ndings and those of previous literature. Our analysis has several novel features that an
di erentiate this study from the existing literature. First, we distinguish between the e e tsof exogenous sho ks to the CABs and systemati endogenous poli y responses. Se ond, we
expli itly measure the monetary transmission e e ts linking the sto k market and the real
e onomy within the VAR framework. Third, we fo us on the role of the CABs as a measureof the overall stan e of un onventional monetary poli y during the QEP period in Japan. We
26
Miyao (2002) estimates the VAR onsisting of all rate, monetary base, sto k pri es, and output in Japan,
all in rst di eren es, and reports that the estimated responses of output to monetary poli y sho ks do not
die27out toward zero.
Sims, Sto k, and Watson (1990) show that the estimated oeÆ ients of a VAR in levels are onsistent andthe distribution of individual estimated parameters is asymptoti ally normal even when variables have unit
roots and there are some variables that form o-integration relationships.

23

ondu t the dis ussion along the lines of these features.
There are the poli y-indu ed hanges identi ed as monetary poli y sho ks and systemati
poli y hanges along with the monetary poli y rea tion fun tion behind the total hanges
in CABs. Our results show that the poli y-indu ed hanges identi ed as monetary poli y
sho ks result in a temporal rise in CABs, whereas systemati poli y hanges in response to
sto k pri e sho ks result in a permanent rise in CABs. This implies that a substantial part ofthe observed in rease in CABs re e ts systemati poli y movements in response to negative
sho ks hitting the Japanese e onomy in the early 2000s when there was a massive and gradualrise in CABs as explained in se tion 2.1.
The fa t that there was a strong negative orrelation between ma roe onomi and sto k
pri e variables and CABs in the early phase of the QEP as shown in subse tion 2.2 does notmean the QEPs were ine e tive on the real e onomy. Our ounterfa tual simulations in subse tion 4.4 suggest that the BOJ avoided a more serious e onomi re ession by systemati allya ommodating the nan ial ondition more than we observed in the early 2000s.
However, this do not imply that systemati monetary poli y a tions reverse the expe tations of low e onomi growth and de ation. Okina and Shiratsuka (2004) and Oda andUeda (2007) nd that the a ommodative monetary poli y a tions during the QEP period
resulted in redu ing longer-term interest rates and attening the yield urve by the monetarypoli y e e t, but that it failed to reverse de ationary expe tations in nan ial markets. They
argue that this is be ause the transmission hannel linking the nan ial and non- nan ial
se tors remained blo ked. In ontrast, we argue that this re e ts that a substantial partof the massive in rease in the CABs was mainly due to systemati poli y responses whi hstimulate no additional aggregate demand, whereas the QEP through its transmission linking
the sto k market and the real e onomy reported in subse tion 4.3 is still e e tive on the real
e onomy even under the de line of the nan ial intermediary fun tions of banks burdened by
nonperforming loans and orporate balan e sheet adjustments.
If we ignored the existen e of the sto k pri e hannel, we would rea h a di erent on lusion
regarding the QEP's e e ts on the real e onomy. In ontrast with our ndings, a large volumeof the previous literature, su h as Kimura, Kobayashi, Muranaga, and Ugai (2003), Fujiwara24

(2006), and Nakajima, Kasuya, and Watanabe (2011), provides empiri al results showingthat their identi ed monetary poli y sho ks have limited impa ts on stimulating e onomi
a tivity. However, these studies do not expli itly take into a ount the transmission linking
sto k market responses and the real e onomy. In fa t, as shown in subse tion 4.3, a large
portion of the QEP e e t on output is due to its transmission.
Finally, we should emphasize that our analysis fo uses on the total e e t of un onventionalmonetary poli y on the sto k market and the real e onomy during the QEP period. In ontrast
with our ndings, Gamba orta, Hofmann, and Peersman (2012) report the empiri al resultsthat the output responses to Japan's expanding monetary base sho ks after the ollapse of
Lehman Brothers in September 2008 are hardly statisti ally di erent from zero. However,monetary base sho ks might not be interpreted as un onventional monetary poli y sho ks.
In fa t, the BOJ did not adopt the CABs as its operating target but implemented a poli yombining the un onventional monetary poli y tools, that is, ommitment to future poli ystan e, quantitative easing, and redit easing, in response to the world nan ial risis. The
di eren e between the ndings in ours and Gamba orta, Hofmann, and Peersman (2012)
might mean that the e e ts of providing ample liquidity to realize the target level of the
CABs in ex ess of the required reserves play a limited role on the real e onomy.
7 Con lusion

This paper has attempted to assess the e e tiveness of un onventional monetary poli y on thema ro e onomy. We have fo used on the hara teristi s of the BOJ's QEP, and have argued
that the CABs held at the BOJ serve as a measure of the overall stan e of un onventionalmonetary poli y during that period. We have also proposed a plausible empiri al framework
to examine the e e ts of monetary poli y and sto k pri e sho ks. Our results using daily data
have indi ated that we should take into a ount the interdependen e between sto k market
and monetary poli y to isolate the nan ial market responses to monetary poli y and themonetary poli y rea tion to nan ial markets. Using a stru tural VAR model with simultaneous intera tion between sto k pri es and poli y de isions, we have obtained reasonably
pre ise impulse response results to monetary poli y and sto k pri e sho ks during Japan's
25

QEP period. The main nding is that un onventional monetary poli y during Japan's QEP
period had a signi ant e e t on the real e onomy, whi h is losely in line with the existing
eviden e under the onventional monetary poli y setting. The output e e ts work throughthe transmission linking the sto k market and the real e onomy, while it plays a limited rolein terms of the pri e e e ts. Our analysis also suggests that the BOJ's systemati poli yresponses mitigate severe downward pressure on the real e onomy generated by the sto kmarket.
The analysis in this paper does not expli itly assess the e e tiveness of di erent types of
un onventional monetary poli y tools. We fo us on assessing the total e e t of un onventional monetary poli y in a similar way as previous VAR studies that examine the e e tsof onventional monetary poli y. However, the BOJ ould impa t the nan ial market andthe real e onomy through the expansion of the size of the BOJ's balan e sheet and also inother ways, su h as by hanging expe tations for the future path of the poli y interest rate
and the omposition of the balan e sheet. The e e tiveness of monetary transmission on thereal e onomy might depend on the di eren es among un onventional monetary poli y tools.
Addressing this issue is beyond the s ope of this paper, but is worthy of future resear h.
Data Appendix

This Appendix des ribes the data series used in this paper. All data are from the NIKKEINEEDS-Finan ial Quest by Nikkei Media Marketing.
Daily series

The basi stan e of monetary poli y is de ided by the Poli y Board at the MPMs. At theMPMs, the Poli y Board dis usses the e onomi and nan ial situation, de ides the guidelines for money market operations and the Bank's monetary poli y stan e for the immediate
future, and announ es de isions immediately after the meeting on erned. Based on theguidelines, the Bank sets the amount of daily money market operations and hooses the typesof operational instruments, and provides and absorbs funds in the market.
We de ne the poli y date as the day when the BOJ announ es the poli y de ision after the26

MPMs. The target level of the CABs is publi ly announ ed immediately after every MPM
day. We naturally think that the poli y announ ement a e ts the nan ial markets later inthe day. However, on 19 Mar h 2001 and 18 September 2001, the MPMs ended at 17:27 and
18:48, respe tively, by whi h time the Tokyo Sto k Ex hange market had already losed. So,
we set the next trading day as the poli y date.
Our full sample is from Mar h 19, 2001 to Mar h 9, 2006{the QEP period. Our sample
in ludes 80 poli y dates. Non-poli y dates are taken to be the day before ea h poli y date.
Sto k Pri e (1) Nikkei 225 sto k average, losing pri e, yen.
Sto k Pri e (2) Tokyo sto k pri e index, losing pri e, 4 January 1968= 100.
CABs
Current a ount balan es, losing pri e, yen.
SpreadSpread between the long-term yields of government bonds (10 years) andtokyo interbank o ered rate (3 months).
Monthly series

We use monthly observations for the period between Mar h 2001 and Mar h 2006.

27

Call Rate
IIP
Core CPI

Un ollateralized overnight all market rate, monthly average, per ent
Index of industrial produ tion, seasonally adjusted series, 2005 average = 100.
Consumer pri e index, ex luding fresh foods, seasonally adjusted series, 2005
average = 100.
Sto k Pri e (1) Nikkei 225 sto k average, end of month, yen.
Sto k Pri e (2) Tokyo sto k pri e index, end of month, 4 January 1968= 100.
CABs
Current a ount balan es, end of month, yen.
EX
Export volume, seasonally adjusted series, yen.
CI
Composite Index of Coin ident E onomi Indi ators, 2005 average = 100.
CGPI
Domesti Corporate Goods Pri e Index, the average pri e level for a xed
basket of apital and onsumer goods paid by produ ers, 2005 average = 100.
omPNikkei ommodity pri e index (42 items), 1970 average = 100.
USIIP
U.S. industrial produ tion index, seasonally adjusted series, 2005 average =100

28

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Journal33

Table 1: Poli y hanges during the QEP period
Date
CAB target
Mar h 19, 2001
Y5 trillion
August 14, 2001
Y6 trillion
September 18, 2001 above Y6 trillion
De ember 19, 2001 Y10{15 trillion
O tober 30, 2002 Y15{20 trillion
Mar h 5, 2003
Y17{22 trillion
April 30, 2003
Y22{27 trillion
May 20, 2003
Y27{30 trillion
O tober 10, 2003 Y27{32 trillion
January 20, 2004 Y30{35 trillion
Mar h 9, 2006
Termination of the QEP

34

Table 2: Standard deviations and ovarian es on full samples, non-poli y and poli y dates
Std. dev. of asset pri es
Covar. with CAB
Full NP D P DFull NP D P DCAB 4.044 3.497 5.238
1
1
1
Nikkei225 1.440 1.621 1.517
0.101 0.771 3.537
TOPIX 1.243 1.289 1.299
0.089 0.268 3.103
The table uses 100 times daily log di eren es for CAB and sto k pri es.

Notes:

35

Table 3: Estimates of the instantaneous e e ts of monetary poli y on sto k returns fromone-day hanges in CAB and sto k pri es.
Nikkei225
TOPIX
Estimate S.E Estimate S.E^het
0.162 (0.052) 0.161 (0.048)^OLS
0.006 (0.010) 0.006 (0.009)
Stat. p-value Stat. p-value
Test of O.I. rest
1.260 [0.262℄ 1.057 [0.304℄
Hausman type Test 6.235 [0.012℄ 10.623 [0.001℄

36

Table 4: The ontemporaneous rea tion of monetary poli y to sto k returns
Nikkei 225
TOPIX
Estimate S.E Estimate S.E^ -2.777 (0.942) -3.668 (1.240)

37

Table 5: Dynami responses to monetary poli y sho ks: Ben hmark and alternative spe i ations

38

Spe i ation
Output
Pri e
SR
CAB
ComP
EX
Steps (in months) 6
12
6
12
0
12
0
12
6
12
6
12
Ben hmark0.452
0.047 0.028 0.019 2.197 3.967 13.561 0.121
Di eren e
0.491 0.147
0.010 0.006-1.960-8.759[1℄
0.377
0.064 0.024 0.015 2.166 3.443 13.369 1.178
Di eren e
0.489 0.200
0.009 0.004-2.322-8.447[2℄0.618 0.179
0.113 0.121
2.253 4.749
13.9100.307
Di eren e
0.599 0.142
0.130 0.131-1.535-8.447[3℄0.314 -0.021
0.031 0.021
2.160 3.009
13.3341.655
Di eren e
0.378
0.058
0.013 0.008-2.184-7.248[4℄
0.499
0.073 0.026 0.017 2.179 4.190 13.454 -0.691 0.446 0.300
Di eren e
0.491
0.103
0.009 0.011-2.273-9.0190.222 0.278
[5℄
0.466
0.037 0.034 0.016 2.085 3.380 12.869 1.442
0.665 -0.098
Di eren e
0.436 -0.001
0.018 0.007-1.771-6.0960.682 -0.076
[6℄
0.392
0.029 0.032 0.028 2.164 3.318 13.357 0.428
Di eren e
0.377
0.073
0.019 0.022-1.941-7.379[7℄
0.381
0.021 0.026 0.016 1.779 3.243 10.983 0.068
Di eren e
0.413
0.109
0.009 0.004-0.934-7.483[8℄0.403 0.437
0.018 0.020
2.240 4.136
13.827
4.206
Di eren e
0.307 0.342
0.008 0.010-2.595 -5.163
For ben hmark and eight di erent spe i ations (see text), the table shows the point estimates of impulse responses in 6 and12 months for output, pri es, omP, and EX, and in 0 and 12 months for SR and CABs ( umulative responses) resulting froma one-standard-deviation monetary poli y sho k. Values in bold indi ate the point estimates signi antly di erent from zero basedon the bootstrapped on den e intervals. Also shown are the di eren es in output, pri es, CABs, omP, and EX e e ts from therestri ted VAR model in whi h sto k returns are in ludeds as an exogeneous variable. Values in bold indi ate that the on den einterval for the baseline spe i ation do not ontain the e e ts obtained under the restri ted VAR model.
Notes:

Table 6: Dynami responses to sto k pri e sho ks: Ben hmark and alternative spe i ations

39

Spe i ation
Output
Pri e
SR
CAB
ComP
EX
Steps (in months) 6
12
6
12
0
12
0
12
6
12
6
12
Ben hmark-0.303-0.1160.008 0.006-4.529 -3.329
6.479
9.049
Di eren e
0.363
0.263
0.040
0.053
1.050
6.194
[1℄
-0.389 -0.164
0.006 0.007-4.422 -3.087
7.091
9.859
Di eren e
0.302
0.204
0.035
0.041
1.149
4.985
[2℄
-0.361-0.004 -0.099 -0.076 -4.765 -3.590 4.974 8.849
Di eren e
0.402
0.509
0.054 0.139
0.806
6.058
[3℄
-0.237-0.0670.007 0.005-4.388 -2.561
6.812
8.200
Di eren e
0.264
0.053
0.046
0.047
1.104
3.881
[4℄
-0.322-0.1230.010 -0.001 -4.747 -3.548 6.402 10.171 -0.126 -0.261
Di eren e
0.506
0.436
0.046
0.061
1.037
8.075
0.703 0.905[5℄-0.220-0.0130.000 -0.002 -4.451 -3.404 6.323 8.331-0.138 0.029
Di eren e
0.359
0.312
0.042
0.043
1.024
5.213
0.592 0.323[6℄-0.201 -0.042-0.002 -0.008 -4.228 -2.525 6.663 8.233
Di eren e
0.355
0.225
0.040
0.055
1.079
5.227
[7℄
-0.360-0.1070.002 0.003-4.708 -3.790
4.150
8.573
Di eren e
0.287
0.261
0.034
0.050
0.672
5.454
[8℄
-0.382 -0.416-0.008 -0.009 -4.453 -5.373 7.723 8.995
Di eren e
0.326
0.403
0.018
0.022
1.251
3.355
For ben hmark and eight di erent spe i ations (see text), the table shows the point estimates of impulse responses in 6 and12 months for output, pri es, omP, and EX, and in 0 and 12 months for SR and CABs ( umulative responses) resulting from a
one-standard-deviation sto k pri e sho k. Values in bold indi ate the point estimates signi antly di erent from zero based on thebootstrapped on den e intervals. Also shown are the di eren es in output, pri es, SR, omP, and EX e e ts from the ounterfa tual
simulation under the hypothesized poli y rea tion, in whi h the CAB is xed. Values in bold indi ate that the on den e interval forthe baseline spe i ation do not ontain the e e ts obtained from the ounterfa tual simulation.
Notes:

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Figure 1: The a tual amount and poli y target of CABs and the a tual level of overnight allrate
The shade areas represent the a tual amount of the CABs (left axis). The bold lines
indi ate the CAB targets during the QEP period (left axis). The dotted lines represent thea tual level of the un ollateralized overnight all market interest rate (right axis).
Note:

40

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Figure 2: Ma roe onomi onditions, sto k market and monetary poli y
The shade areas indi ate the QEP period.

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Figure 3: Impulse responses to a monetary poli y sho k
The solid lines represent the point estimates of the impulse responses to a monetarypoli y sho k in the baseline VAR model. The shaded areas represent 16th and 84th per entile
error bands al ulated by the bias-adjusted bootstrap method with 10000 repli ations.
Note:

42

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Figure 4: Impulse responses omparison
The solid lines represent the point estimates of the impulse responses to a monetarypoli y sho k in the baseline VAR model. The solid lines with + symbols represent the e e tsof the monetary poli y sho ks identi ed from the restri ted VAR model in whi h sto k returns
are in luded as an exogenous variable. The dotted lines represent the e e ts of the poli y
sho ks identi ed from the restri ted VAR model under the re ursive assumption.

Notes:

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Figure 5: Impulse responses to a sto k pri e sho k: baseline and no poli y response
The solid lines represent the point estimates of the impulse responses to a negative-onestandard-deviation sto k pri e sho k in the baseline VAR model. The shaded areas represent
16th and 84th per entile error bands al ulated by the bias-adjusted bootstrap method with
10000 repli ations. The solid lines with + symbols represent the impulse responses for asystem in whi h the model's estimated monetary poli y rea tion fun tion is repla ed by one
in whi h CAB is ompletely unresponsive to other variables in the system.
Note:44