Draft:Stock Return and Inflation
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The relationship between stock market returns and inflation refers to stock market performance under various inflation environments.
Facts
[edit]Under normal circumstances, equity prices tend to decline when inflation rises. For instance, stock prices dropped sharply around the world in 2022 following sudden inflation spikes.[1] Researchers typically find negative correlations between real stock market returns and inflation.
Economic Reasons
[edit]The economic literature offers several explanations for the observed negative relationship.
Inflation illusion: The argument states that investors misprice stocks by sticking to historical patterns in new inflation regimes.[2]
Time-varying risk aversion: Higher inflation raises the population's risk aversion and reduces consumption.[3]
Monetary policy: Central banks tighten monetary policy to counter inflation, and higher funding costs lead to stock market falls.[4] The exact degrees of influence is determined by monetary policy cyclicality, framework, and flexibility.[5]
Tax effects: Rising prices translate into larger tax burdens under certain tax rules when tax brackets and depreciation thresholds are fixed in nominal terms.[6]
References
[edit]- ^ "How 2022 shocked, rocked and rolled global markets". Reuters.
- ^ Modigliani, Franco; Cohn, Richard A. (1979). "Inflation, Rational Valuation and the Market". Financial Analysts Journal. 35 (2): 24–44. ISSN 0015-198X.
- ^ Brandt, Michael W.; Wang, Kevin Q. (2003-10-01). "Time-varying risk aversion and unexpected inflation". Journal of Monetary Economics. 50 (7): 1457–1498. doi:10.1016/j.jmoneco.2003.08.001. ISSN 0304-3932.
- ^ Bakshi, Gurdip S.; Chen, Zhiwu (1996). "Inflation, Asset Prices, and the Term Structure of Interest Rates in Monetary Economies". The Review of Financial Studies. 9 (1): 241–275. ISSN 0893-9454.
- ^ "Stock Returns and Inflation Redux: An Explanation from Monetary Policy in Advanced and Emerging Markets". IMF. Retrieved 2024-12-20.
- ^ Feldstein, Martin (1980). "Inflation and the Stock Market". The American Economic Review. 70 (5): 839–847. ISSN 0002-8282.