How Macroeconomic Shocks Impact the Japanese Economy: Evidence from the stock market

Many shocks have buffeted the Japanese economy since 2012. The monetary base increased fourfold between 2013 and 2024 as the Bank of Japan pursued its two percent inflation target. The yen, after appreciating 40% against the U.S. dollar between June 2007 and December 2012, depreciated 60% between the beginning of 2013 and the end of 2024. World demand has fluctuated with rising tariffs, the COVID-19 pandemic, and other external events. Dubai crude oil prices fell from $108 in January 2013 to $28 in January 2016 and then rebounded to $112 in January 2022.

This paper investigates how these and other shocks affect Japanese sectoral stock prices. Investigating how economic news impacts share prices can shed light on how it affects the broader economy. In theory stock prices equal the expected present value of future cash flows. Factors that increase sectoral stock returns portend higher sectoral earnings. As Black (1987, p. 113) noted, “The sector-by-sector behavior of stocks is useful in predicting sector-by-sector changes in output, profits, or investment. When stocks in a given sector go up, more often than not that sector will show a rise in sales, earnings, and outlays for plant and equipment.”

The evidence indicates that world demand and the value of the yen are especially important for the Japanese economy. All 86 sectors investigated have statistically significant exposures to these two variable. In addition, Figure 1A shows that in almost half of the months investigated between 2013 and 2025, investors reacted to expectations of changes in world demand. Figure 1B shows that in 37% of the months investigated, they reacted to expectations of changes in the yen/dollar exchange rate. News of changes in world demand and the yen/dollar exchange rate frequently drove fluctuations in the aggregate Japanese stock market of greater than 10% in a single month. These findings indicate that the international economy is vital for the Japanese economy.

Japanese firms occupy key niches in global value chains. For instance, Murata makes ceramic capacitors, Sony makes image sensors, Shimano makes bicycle parts, and JSW makes nuclear reactor parts. These specialized products are crucial to many global industries.

It is essential for the Japanese economy to maintain technological advantages in these niches. Technological competition with Asian neighbors is fierce. The Japanese government should make sure know-how is not pilfered nor that it inadvertently falls into competitors’ hands.

Since Japanese firms play such a vital role in the world economy, their interest in unencumbered trade is immense. The Trump Administration is engaged in a tariff war, but the protectionist pressures have been building for decades. Rather than only undertaking transactional exchanges with the U.S., Japan should engage with the U.S. and other countries to address the causes of global imbalances. High on the list should be encouraging the U.S. to reduce its budget deficit.

In addition, the Japanese government should seek as much as possible to maintain free trade with countries other than the U.S. Protectionism is contagious, and Japan and other countries suffering from U.S. tariffs should strive to maintain open markets with each other.

The Japanese government should also help firms through export promotion activities. For instance, Makioka (2021) found that government support for firms to attend trade fairs led to significant increases in exports. Much of this increase was along the extensive margin. He also reported that the impact was far larger for trade fairs outside of Asia. Thus the government should help firms to not only penetrate markets that are close by but also to enter new markets that are far away.

Finally, given uncertainties in the global economy, any steps that would help firms to supply to the domestic market would be desirable. This could include sponsoring research and development for products that can help with the demographic transition. One example is medical devices that treat Alzheimer’s disease. Another example is robots that could replace workers in manufacturing and services. As Japan’s population ages, there will be many needs for products that cater to aging citizens and that mitigate worker shortages.

Notes: Figure 1A presents the changes in returns on the aggregate Japanese stock market associated with world demand as represented by the return on the world stock market. Figure 1B presents the changes in returns on the aggregate Japanese stock market associated with changes in the yen/dollar exchange rate. Figure 1B also presents the yen/dollar exchange rate. To calculate the changes in returns associated with world demand and the yen/dollar exchange rate, returns on 86 assets are first regressed on 1) the change in the breakeven inflation rate (i.e., the difference between the yield on 10-year Japanese government bonds (JGBs) and the yield on 10-year inflation indexed JGBs), 2) the return on the world stock market, 3) the change in the log of the spot price of Dubai crude oil, 4) the yen/dollar nominal exchange rate, 5) Krippner’s (2013) shadow monetary policy rate, 6) the interest rate on 10-year inflation indexed JGBs, and 7) a dummy variable for 5 August 2024 when monetary policy news roiled the Japanese stock market. The sample period for this time series regression extends from 1 January 2013 to 12 March 2025. If investors believe that the return on the world stock market or the yen/dollar exchange rate will increase, they will drive up prices for assets that benefit from increases in the return on the world stock market or the yen/dollar exchange rate and drive down prices of assets that are harmed by increases in these variables. There should thus be a positive cross-sectional relationship between asset returns and assets’ regression coefficients to the return on the world stock market or the yen/dollar exchange rate on months when they foresee increases in the world stock market or the yen/dollar exchange rate and a negative relationship on months when they foresee decreases. For each month between January 2013 and June 2025, returns on the 86 assets are thus regressed on the assets’ regression coefficients for these two macroeconomic variables. The figures contain all months when there is a statistically significant cross-sectional relationship at at least the 10% level between returns on the 86 assets and their betas to world stock returns and the yen/dollar exchange rate. To facilitate interpretation, the monthly cross-sectional regression coefficients are multiplied by the corresponding time series regression coefficients for world stock market returns and the yen/dollar exchange rate when the left-hand-side variable is the returns on the aggregate Japanese stock market. The values on the vertical axis can thus be interpreted as how news of the macroeconomic variable impacts returns on the aggregate Japanese market.