Must-read: Tamim Bayoumi and Joseph E. Gagnon: “Time to Be Bold, Mr. Kuroda”

Must-Read: Tamim Bayoumi and Joseph E. Gagnon: Time to Be Bold, Mr. Kuroda: “The surprise decision by the Bank of Japan (BOJ) last Thursday to leave policies essentially unchanged…

…while downgrading the growth and inflation forecasts has unnerved markets…. Markets needed a surprise, but this one was in the wrong direction. What is required is a bold initiative rather than renewed paralysis…. Strong, decisive policy action is needed—and soon—to convince markets the BOJ is still determined to achieve 2 percent inflation. With 10-year government bond yields now below zero, the most effective option is to ramp up purchases of other assets. Currently, the BOJ is buying about 0.5 percent of outstanding equities per year. Raising the rate of purchase to 10 percent would herald a major break with the past, pushing up equity prices and encouraging consumption and investment through higher household wealth and lower cost of capital.

Must-read: Olivier Blanchard and Joseph E. Gagnon: “Are US Stocks Overvalued?”

Must-Read: I think that this is completely right: expected returns on U.S. stocks right now are lower than average, but the gap between expected returns on stocks and on other assets is significantly higher than average:

Olivier Blanchard and Joseph E. Gagnon: Are US Stocks Overvalued?: “Are stocks obviously overvalued?…

…The answer is no, and the reason is straightforward…. What matters for the valuation of stocks is the relation between future growth and future interest rates. Put another way, the equity premium… has if anything increased relative to where it was before the crisis…. The Shiller P/E ratio reached 26 late last year and is currently around 24, compared with a 60-year average of 20. This elevated Shiller P/E measure is commonly cited as an indicator that stocks may be overpriced, including by Shiller himself….

The deviations of the P/E from its historical average are in fact quite modest. But suppose that we see them as significant, that we believe they indicate the expected return on stocks is unusually low relative to history. Is it low with respect to the expected return on other assets?… [But] in all six cases, the equity premium is higher in 2015 than in 2005. Put another way, stock prices were more undervalued in 2015 than they were in 2005….

If you accept current forecasts, and you accept the notion that stocks were not overvalued in the mid-2000s, then you have to conclude that stocks are not overvalued today. If anything, the evidence from 150 years of data is that the equity premium tends to be high after a financial crisis, and then to slowly decline over the following decades, presumably as memories of the crisis gradually dissipate. If this is the case, then stocks look quite attractive for the long run…