Rejoinder to Mr. Littleboy

Takahiro MIYAO (Professor, GLOCOM)

This comment originally appeared in the "Japan-U.S. Discussion Fourm" (http://lists.nbr.org/japanforum) on May 10, 2003: posted here with the author's permission.

In his commentary (http://www.glocom.org/debates/20030512_littleboy_com/), Mr. Littleboy wrote:

"It appears to me that both stocks (as seen by PER) and real estate/housing prices (expected return based on, say, expected rental income) remain overvalued by normal standards."

I appreciated Mr. Littleboy's comment on my argument, because that will help clarify my main point.

The situation that he described is exactly what I called the "vicious circle" of asset deflation. If the PER appears too high in the case of present day Japan, a resultant drop in asset prices would further depress the economy and returns on these assets as well as the future expected rates of returns and growth, reducing both the numerator and the denominator of the PER at the same time and leading to further drops in asset prices.

We need to get out of this low (vicious circle) equilibrium and do something to push up the economy to a higher level equilibrium, where a high PER level may be justified due to a high level of expected growth rates of future returns and growth, due to an expanding economy with increasing asset prices. It is crucial to realize that we are living in a world of huge asset markets, where there tend to be multiple equilibria of extremes and a "normal" situation is quite unstable and unsustainable. Unfortunately, there are so few economists and policymakers who understand this important point. Alan Greenspan understands this and has been successful in keeping the U.S. economy from slipping into a low-level equilibrium with declining asset prices and returns simultaneously.