Monetary Policy Through the Stock Market: Central Bank Purchase of Equity Index ETFs

Abstract

As part of its unconventional monetary policy, since 2010 the Bank of Japan (BOJ) has purchased equity index exchange-traded funds (ETFs). The total purchased amount reached 3% of GDP and the bank has become among the largest shareholders in over 40% of listed companies. Because of the reduction in float shares and the non-informational nature of the BOJ purchases, liquidity and price informativeness of the underlying shares deteriorates, increasing friction in the share market. The number of shareholders, institutional ownership, and analyst coverage all decreased for firms in which the BOJ holds shares. These firms issue fewer shares. Although the BOJ’s ETF purchase might increase share prices, the increase in both illiquidity and downside risk limit the share price increases. Although the equity cost of capital decreases for firms with disproportionately large BOJ holdings, the cost of increased illiquidity might have wider effects for the all listed firms.

Keywords: ETFs, equity market, liquidity, market efficiency, unconventional monetary policy

JEL Classification: E52, E58, G10, G14