Statement by Alan Greenspan, Chairman, Board of Governors of the Federal Reserve System, before the Committee on Banking, Housing, and Urban Affairs, U.S. Senate, April 17, 1992

Federal Reserve Bulletin, June 1992 | Go to article overview

Statement by Alan Greenspan, Chairman, Board of Governors of the Federal Reserve System, before the Committee on Banking, Housing, and Urban Affairs, U.S. Senate, April 17, 1992


Statement by Alan Greenspan, Chairman, Board of Governors of the Federal Reserve System, before the Committee on Banking, Housing, and Urban Affairs, U.S. Senate, April 17, 1992

I am pleased to appear today to discuss, as you requested, recent stock market developments in Japan. I think that it is useful to review these developments from a longer time perspective than that of just the past few weeks. I also will address the implications for Japanese banks and for the overall performance and prospects for the Japanese and world economies.

Japanese stock prices nearly tripled from the end of 1985 to the end of 1989. The reasons for this increase are not completely clear. It seems to have been fueled, in part, by the low interest rates associated with an expansionary monetary policy adopted by the Bank of Japan from February 1985 to December 1987. This initiative was directed at countering the contractionary effects on the Japanese economy of the doubling of the yen's exchange value against the dollar. Land prices in Japan also soared during this period, reinforcing the rise in stock prices because Japanese corporations are major land owners. Although other world stock markets were also generally booming in the early part of this period, the Japanese market far outpaced the markets of other industrial economies.

Profits of Japanese corporations increased very strongly--9V2 percent per year in 1987 and 1988--but stock prices rose at a much faster rate. As a result, conventional price-earnings ratios hit a peak of more than 70 in August 1987, which was about three to five times the PE ratios in other major markets. Even after adjusting for certain accounting differences (primarily with respect to depreciation allowances) and the prevalence of cross-share holdings among Japanese corporations, Japanese PE ratios were still twice the ratios of other major equity markets.

The reaction of the Japanese stock market to the October 1987 contraction in the U.S. market was particularly mild. And the Japanese market resumed its rapid rise in early 1988, regained its August 1987 highs by mid-1988, and continued to soar until year-end 1989.

Just as the reasons for the sharp increase in stock prices are not entirely clear, so too the factors behind the decline that began in 1990 cannot be enumerated with full confidence. Indeed, the decline may be at least partly a correction from an inexplicable and unsustainable high level. Under such conditions any random event can engender a contraction.

Nonetheless, monetary policy has been an important influence. Policy tightening in Japan began in earnest in mid-1989, largely with the avowed intent of curbing the land and stock price bubble before it was perceived to take on uncontrollable dimensions. By late 1990, nominal short-term interest rates had risen 350 basis points. The growth rate of M2+CDs (the Bank of Japan's targeted aggregate) plummeted in response. Real long-term interest rates rose more than 200 basis points from late 1989 until late 1990.

Stock market prices declined 40 percent in 1990, dropping particularly sharply after the Iraqi invasion of Kuwait. After having rallied briskly along with other major stock markets in the wake of the allied victory in the Persian Gulf war, the Japanese market seesawed through most of 1991. Late in the year, however, amid growing anxieties over the slowing of economic activity in Japan, a rapidly worsening profit outlook, and recurring revelations of financial market improprieties, stock prices began a renewed plunge. From the end of October 1991 through April 16, 1992, the market fell a further 30 percent. This has occurred despite a significant easing of monetary policy.

This latest decline in Japanese stock prices brought conventional Japanese PE ratios down to the neighborhood of 30 or so, somewhat above that for the S&P 500 in the U.S. market. Doubtless, adjusted PE ratios for Japanese stocks are lower than this, and other valuation measures such as price-to-book-value or price-to-freecash-flow are less elevated.

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Statement by Alan Greenspan, Chairman, Board of Governors of the Federal Reserve System, before the Committee on Banking, Housing, and Urban Affairs, U.S. Senate, April 17, 1992
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