Bubbles in Japan's Stock Market: A Macroeconomic Analysis

Abstract

Since the 1950s, Japan's stock market has gone into bubbles every ten years or so (early 1950s, early 1960s, and early 1970s). Then the 1980s saw a strong bubble that continued for several years (late 1982 to the end of 1989). What caused this bubble to be so strong? Our analysis of the fundamental equation reveals that the key factor was the nominal interest rate which continued to decline until the late 1980s owing to the extremely relaxed monetary policy pursued by the Bank of Japan. The forecasts for stock prices made by investors added to the effect of the low interest rates. We will show that investors tend to forecast fluctuations on the real side two-to three-quarters ahead of time. The bubble crashed when the forecasts of the investors collapsed. Since then investors have remained bearish and the stock market has remained in the doldrums.

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