The financial crisis forced a change in government in many democratic countries in the world, e.g. the United States, United Kingdom or France. In others it led to stabilization of the government, like in Germany. That raises the question, if there is connection between politics and financial markets. It seems obvious that governments are effected by financial instability but how do changes in government influence financial markets?
To answer this question a look a Japan seems appropriate. After the defeat in World War II Japan recovered quickly and rose to one of the leading nations not only in Asia but the whole world. This development came to a stop in the beginning 1990ies. The following decades are now referred to as “the lost two decades”, where Japan fell behind in comparison to other leading economies in the world. (Avent, 2012)
In Japans politics it is common to have frequent changes in government and therefore short periods of governance. With his second term Shinzo Abe now marks the 18th prime minister of the Heisei period. (Prime Minister of Japan and His Cabinet, 2015) None of the previous heads of government were able to change the economic climate of the country. In the first decade of the 21st century the GDP took a slope downwards of $1 trillion in nominal terms (Google, Inc., 2015) and in contrast to western financial markets, which benefitted from the dot-com boom, Japans markets deteriorated (Reszat, 2013, p. 12f). So it seems Japanese governments are not able to help the economy and influence financial markets in the process.
But with the reelection of Shinzo Abe in late 2012 something changed. Following his election there was a clear improvement in performance of financial markets in Japan. The Nikkei index shows this development. It went from under 9,000 to over 17,500 in the short period of one and a half years (Bloomberg, 2015). So what changed during this time? Abe implemented an economic recovery program, now referred to as Abenomics (Financial Times, 2015), which consists of three arrows: fiscal stimulus, monetary easing and structural reforms (International Monetary Fund, 2013, p. 4). Combined they ought to boost economic growth. In this plan the Bank of Japan plays a major role. In consensus with the government it raised the money supply, in order to increase investments. The question about independence remains.
Chart 1 | Own diagram based on Bloomberg, 2015 and TradingEconomics, 2015
A look at the timeline of events gives a clearer view about the correlation. Directly after the election of Shinzo Abe, the Nikkei index did not show strong signs of change. In the implementation of Abenomics on the other hand, there is a significant rise to be seen. Since then there has been steady and lasting growth. So, not the change in government influenced the financial market, but the change in policy and the prospect of reforms. Abe’s case shows this very clearly, especially in comparison to his first term as prime minister. Back then there were no major changes in policy and therefore he was not able to fuel economic growth. Now he has established drastic measures and they make a difference. So it is the change in policy, not in government, that influences financial markets. Another example for this hypothesis is Germany, where the head of government and the governing party did not change but a shift in policy of the same cabinet led to growth in financial markets (financen.net, 2015).
Nevertheless, the jump of the Nikkei index raises the question, where the growth really comes from. With the process of quantitative easing the worth of the Yen deteriorated internationally. That improved the conditions for foreign investors. FDI took a leap up in the last years for Japan. (Chart 1) So the connection is rather simple. With the devaluation of the Yen, foreign investors fuel the performance of Japanese financial markets. But that development is considered dangerous. The term Abegeddon has arisen, to stress that the measures taken by the Japanese government, in case of failure, will lead to a catastrophe (Tasker, 2013).
Without a doubt there is a connection between a change in government and financial markets. But this is not because of the change itself but because the shift in policies, that it is accompanied by. In this process the personality of the elected plays a major role. Abe lost a lot of his credibility in the end of his first term. Psychological aspects have to be taken into account as well. Now he did regain a lot of it and people believe that he will bring the change. Although there are many voices claiming Abenomics has failed already, only the future will show, if that is true. For Japanese financial markets it is prosperous right now.
In conclusion to the question, if changes in government really matter for financial markets, the answer must be: no, not really. The side effects of the changes in governments affect financial markets, but not the change itself. Also financial markets are able operate without governments per se. It is their regulations and interventions that alter the development. For that matter the true question must ask, if actions of the government really matter for financial markets and if they better or worsen their performance.
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Bloomberg. (2015). NKY Chart - Nikkei 225 Index. Retrieved January 19, 2015, from http://www.bloomberg.com/quote/NKY:IND/chart
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Tasker, P. (2013). Markets Insight: Never mind Abegeddon, Japan needs more medicine. Financial Times. Retrieved January 24, 2015, from http://www.ft.com/intl/cms/s/0/c51be10a-d65f-11e2-b03f-00144feab7de.html...
TradingEconomics. (2015). Japan Foreign Direct Investment | 1996-2015. Retrieved January 24, 2015, from http://www.tradingeconomics.com/japan/foreign-direct-investment
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