Comment on “Response of Asset Prices to Monetary Policy under Abenomics”


Correspondence: Kosuke Aoki, Faculty of Economics, The University of Tokyo, 7-3-1 Hongo, Bunkyo-ku, Tokyo, Japan. Email:

Ueda (2013) provides an interesting analysis of the recent reaction of asset prices in Japan to the recent monetary easing associated with the so-called Abenomics. He finds that speculative trade by foreign investors is the main driver of the sharp increases in asset prices. In addition, Ueda argues that those foreign investors may not have a correct understanding of how nonconventional monetary policy (NCM) works. Nonetheless, their beliefs that an anticipated monetary easing can increase asset prices might become self-fulfilling.

Ueda (2013) first summarizes how three types of NCM measures work. Those are “large-scale asset purchases,” “quantitative easing,” and “forward guidance of interest rates and/or future asset purchases.” Different policy measures have different transmission channels. Then Ueda moves on to an empirical analysis of the effectiveness of NCM measures in the USA and Japan. The empirical strategy employed is an event-type regression analysis. It is shown that asset prices reacted significantly to NCM under Abenomics. An interesting finding is that the rally was mainly led by foreign investors. Ueda argues that foreign investors may have illusions about what the Bank of Japan (BOJ) will be able to do in the near future. He gave a number of informal, but convincing, examples that indicate that foreign investors are confused about the effectiveness of NCM. Ueda concludes that there is a good chance that the market is overconfident about the BOJ's ability to raise inflation, and this is due to the market's inability to distinguish between some essential differences of the different types of NCM. If the markets are overconfident, then it is most likely that they will be disappointed later on. Nonetheless, Ueda (2013) speculates that such incorrect beliefs about the effectiveness of Abenomics might be self-fulfilling.

Standard economic theories predict that such illusions or incorrect beliefs should be short-lived in asset markets. This is because rational investors can exploit the wrong beliefs of irrational investors. Those irrational investors lose money and will eventually be crowded out from the markets.

However, there are some occasions in which expectations not based on fundamentals, either rational or irrational, become self-fulfilling. Below I provide two theoretical possibilities that may be consistent with Ueda's (2013) arguments.

My first example is sunspot fluctuations associated with the indeterminacy of rational expectations equilibrium in monetary models. Benhabib et al. (2001) show that in the presence of a zero lower bound on the nominal interest rate, interest rate rules result in multiple rational expectations equilibria. One equilibrium is the normal equilibrium in which inflation fluctuates around the inflation target of the central bank. There is another steady-state equilibrium where the nominal interest rate is stuck at zero and the inflation rate is negative – the liquidity trap. Benhabib et al. also show that the liquidity trap equilibrium is locally indeterminate. This means that in the neighborhood of this equilibrium, many equilibria exist in which inflation and other aggregate activity fluctuate in response to nonfundamental revisions in expectations.

Since the nominal interest rate in Japan has long been stuck at zero, there is some chance that Japan is in a liquidity trap equilibrium. Then the economy can respond to sunspot events according to Benhabib et al. (2001). Nonfundamental revisions in expectations can include the market's reaction to announcements of various types of NCM measures. Even though their transmission mechanism to the real economy is either unclear or weak, if market participants could coordinate their beliefs to respond to those announcements, their expectations become self-fulfilling, and asset prices can persistently change.

The second possibility is that even though the agent's understanding of how NCM works is not correct, it could become self-confirming. This can be an example of self-confirming equilibria analyzed in Sargent (1999). Imagine that agents use a mis-specified economic model to generate their expectations about the future course of economic activity. One may wonder that as agents observe data, they eventually learn the true structure of the economy. However, Sargent (1999) shows that there are some cases in which agents cannot detect their model mis-specification by observing data because the data (generated by “true” model) becomes consistent with their wrong model. In such cases, their mis-specified beliefs are self-confirmed.

This logic can be applied to the case of NCM. Since evidence on the effectiveness of NCM measures is mixed, it may well be the case that market participants are confused about NCM as Ueda (2013) argues. In addition to this, since the data are limited, it may be very difficult for agents to learn with confidence about how those policies actually work. In other words, it is not easy for them to determine that their understanding is not correct. Then expectations based on wrong beliefs can survive for a long period of time.

In both cases, expectations can become self-fulfilling. Since the effectiveness of monetary policy, either conventional interest policy or unconventional monetary policy, depends crucially on expectations, it would be very important for students of monetary economics to do further research on how agents form expectations.