Stock Market Responses Under Quantitative Easing: State Dependence and Transparency in Monetary Policy

• Author: Yoshiyuki Nakazono,Satoshi Ikeda
• Published date: 01 December 2016
• DOI: http://doi.org/10.1111/1468-0106.12158
• Date: 01 December 2016

STOCK MARKET RESPONSES UNDER QUANTITATIVE

EASING: STATE DEPENDENCE AND TRANSPARENCY IN

MONETARY POLICY

YOSHIYUKI NAKAZONO*Yokohama City University

SATOSHI IKEDA State Street Trust and Banking

Abstract. This paper evaluates the effects of unconventional monetary policies adopted by the Bank

of Japan from the year 2001 to 2006. A new measure is proposed to identify a nontraditional mo-

netary policy shock from policy packages under the zero lower bound of short-term nominal interest

rates during the quantitative easing period, using data on intraday 3-month Euroyen futures rates.

We find that stock markets do not react to a policy surprise in an expected manner and negatively

respond to a monetary easing surprise. Moreover, we find an asymmetric response during a boom

and a recession and a nonlinear reaction because of increasing uncertainty concerning future infla-

tion dynamics and the enhancement of monetary policy transparency. Our result suggests that it is

difficult to implement unconventional monetary policy to manage agents’expectations and a ‘lean

against the wind’policy to prevent asset bubbles, particularly at the zero bound.

1. INTRODUCTION

Increasing attention is being paid to the effects of nontraditional monetary

policies of central banks in developed countries. Such policies include asset

purchase programmes and commitment to maintaining easing policies until

inflation rates improve. This is because countries rely on monetary policy to un-

derpin economic activities, such as the stabilization policy during deflationary

periods in Japan and following the recent financial turmoil in the United States

and Europe. Now that the central banks in developed countries, such as the

Federal Reserve and the European Central Bank, also adopt nonstandard

monetary policies, including explicit expectation management and large-scale asset

purchase programmes, it is important to investigate the effects of unconventional

monetary policies on economic activities. Many countries now shoulder a substan-

tial debt burden; thus, policy makers have a strong interest in unconventional

monetary policy, which is one of the few macroeconomic policies left remaining.

However, there is no definitive conclusion as to the effects of unconventional mon-

etary policy on macroeconomic variables and financial markets. It is not easy to exam-

ine the effects of nonstandard monetary policy; a conventional way of identifying a

monetary policy shock is no longer valid under the zero lower bound on short-term

nominal interest rates. For example, the Bank of Japan lowered the overnight call

rates to almost 0% and changed the main operating target for money market opera-

tions from the current uncollateralized overnight call rate to the outstanding balance

of thecur rent accounts in 2001.At the same time, the Bank of Japan gave more de-

tailed description of the commitment to maintaining the easing policy until the

*Address for Correspondence: International College of Arts and Sciences, Yokohama City Univer-

sity, E-mail: nakazono@yokohama-cu.ac.jp

Pacific Economic Review, 21: 5 (2016) pp. 560–580

doi: 10.1111/1468-0106.12158

© 2016 John Wiley & Sons Australia, Ltd

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consumer priceindex (nationwide statisticsexclude perishables) reachesstability at

0% or higher on a year-on-year basis,1and announced increases in the outright

purchase of long-term government bonds. While the Bank of Japan adopted the

policy package to stimulate the economy, it is difficult for researchers to capture

a nontraditional monetary policy surprise in a traditional way such as measuring

change in overnight call rates around the policy window.

Based on recent nonstandard monetary policy developments, the present

paper proposes a new measure to identify a shock from quantitative easing by

the Bank of Japan during the period 2001 to 2006 and evaluates the effects on

stock markets using the intraday data on 3-month Euroyen futures.2Instead

of employing a conventional identification process, such as using overnight call

rates or the amount of current account balances that represents the policy target

during the quantitative easing period, we adopt the Euroyen futures rate that un-

derlies the 3-month London Interbank Offered Rate (LIBOR) to measure the

unconventional monetary policy shock from a policy package, including, for in-

stance, a commitment policy, asset purchasing programmes and the accumula-

tion of current account balances.

Several published studies, including Baumeister and Benati (2013), Bernanke

et al. (2004), Florackis et al. (2014), Fujiki and Shiratsuka (2002), Fujiwara

(2006), Inoue and Okimoto (2008), Iwata and Wu (2006), Nakajima (2011),

Nakajima et al. (2011) and Schenkelberg and Watzka (2013) elaborate on the

identification of a monetary policy surprise under the zero lower bound. Based

on a vector autoregression approach, Fujiwara (2006), Inoue and Okimoto

(2008), Nakajima (2011), Nakajima et al. (2011) and Schenkelberg and Watzka

(2013) study the effects of monetary policy at the zero bound. However, the data

used in Fujiki and Shiratsuka (2002), Fujiwara (2006) and Inoue and Okimoto

(2008) are limited before 2003, and Nakajima (2011) assumes that short-term in-

terest rates have a fixed lower bound. Although Schenkelberg and Watzka

(2013) cover the quantitative easing period, they do not consider the effects of

a commitment policy for the management of expectations, which is the key con-

cept for conducting monetary policy at the zero bound.3

Using a new measure, we propose that financial markets do not react to a

policy surprise in the way that economic theory would predict; rather, the finan-

cial markets respond negatively even to monetary easing and contrary to expec-

tations. The evidence that a tightening surprise is positively related to stock

returns is consistent with the literature on the state-dependent reaction in

Kontonikas et al. (2013). Second, we find a complex reaction by stock markets

to a policy surprise at the zero bound. As unexpected, monetary policy tighte-

ning decreases stock prices, which is consistent with economic theory; stock

prices also decrease, even when an unexpected monetary policy shock is

accommodative. Third, we find that the nonlinear response vanishes after the

1(Ueda, 2012b) notes that this policy commitment is an explicit version of expectations

management.

2Three-month Euroyen futures are listed on the Tokyo Financial Exchange.

3See (Eggertsson and Woodford, 2003) and (Eggertsson and Woodford, 2004)

STOCK MARKET RESPONSES UNDER QUANTITATIVE EASING 561

© 2016 John Wiley & Sons Australia, Ltd