Can macroeconomic variables explain long term stock market movements? A comparison of the US and Japan

Within the framework of a standard discounted value model we examine whether a number of macroeconomic variables influence stock prices in the US and Japan. A cointegration analysis is applied in order to model the long term relationship between industrial production, the consumer price index, money supply, long term interest rates and stock prices in the US and Japan. For the US we find the data are consistent with a single cointegrating vector, where stock prices are positively related to industrial production and negatively related to both the consumer price index and a long term interest rate. We also find an insignificant (although positive) relationship between US stock prices and the money supply. However, for the Japanese data we find two cointegrating vectors. We find for one vector that stock prices are influenced positively by industrial production and negatively by the money supply. For the second cointegrating vector we find industrial production to be negatively influenced by the consumer price index and a long term interest rate. These contrasting results may be due to the slump in the Japanese economy during the 1990s and consequent liquidity trap.Stock Market Indices, Cointegration, Interest Rates.

Independence Day for the “Old Lady? A Natural Experiment on the Implications of Central Bank Independence

Central bank independence is widely thought be a sine qua non of a credible commitment to price stability. The surprise decision by the UK government to grant operational independence to the Bank of England in 1997 affords us a natural experiment with which to gauge the impact on the yield curve from the adoption of central bank independence. We document the extent to which the decision to grant independence was ‘news?and illustrate that the reduction in medium and long term nominal interest rates was some 50 basis points, which we show to be consistent with a sharp increase in policymaker’s aversion to inflation deviations from target. We suggest therefore central bank independence represents one of the clearest signals available to elected politicians about their preferences on the control of inflation.Central bank independence; preferences; yield curve.