This paper examines the relationship in Japan between asset price inflation and macroeconomic variables, and in particular monetary factors. The focus is on land price inflation, rather than stock price movements; while stock prices are difficult to model empirically, land prices generally move systematically in response to changes in economic fundamentals. Several related questions are investigated: (1) was there a structural break in the way monetary factors affected asset prices in the 1980s; (2) did monetary factors contribute importantly to asset price inflation in the 1980s; (3) what accounted for the divergent behavior of asset prices and consumer prices; and (4) is there support for the view that the effects of monetary factors were “concentrated” in asset markets rather than in goods markets?
The paper finds strong evidence of a shift in the relationships between monetary factors and land prices in the early 1980s: in particular, the parameters of an estimated vector autoregression imply that the transmission of monetary factors to asset prices was greater in the 1980s than in the 1970s. A key conclusion is that monetary shocks led to more asset price inflation and less consumer price inflation in 1984-93 than during 1970-83. This “shift in regime”--which is largely attributed to the effects of financial liberalization--concealed the true, unsustainable, nature of the rise in asset prices in the late 1980s, which may explain why policymakers did not fully perceive the implications of allowing the asset price inflation to proceed as far as it did.