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Inflation and asset prices

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  • Tatom, John

Abstract

Changes in the general level of prices and inflation have profound effects on asset prices. There are several reasons for these effects and the influence differs depending on the source of the inflation and whether it is expected or not. To understand these effects it is important to clarify what is meant by inflation, the pure theory of the sources of inflation, how inflation affects goods and services prices and how it affects the assets that are used to finance production, both equity prices and fixed income assets. This article reviews the theory of inflation, its sources and effects on asset prices, especially equity, bond and real asset prices. The simplest and broadest economic model suggests that money is a veil and that changes in its value (the price level and its rate of depreciation (inflation) have no real effect s on the economy, especially asset prices and real rates of return on assets. There are a variety of reasons to expect that inflation is not “neutral,” however. This article focuses on several factors that give rise to real adverse effects of inflation on asset prices, including supply shocks that reduce wealth and raise prices, and tax effects of inflation that arise from a lack of full indexation of the tax system. Inflation has had large effects on asset prices in the United States, especially during the Great Inflation from 1965 to 1984. The evidence here supports these sources of real effects of inflation.

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Bibliographic Info

Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 34606.

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Date of creation: Nov 2011
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Handle: RePEc:pra:mprapa:34606

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Keywords: Inflation; asset prices; supply shocks; real rate of interest; real rate of return on equity;

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  1. Margaret M. McConnell & Gabriel Perez Quiros, 1997. "Output fluctuations in the United States: what has changed since the early 1980s?," Research Paper 9735, Federal Reserve Bank of New York.
  2. Michael T. Kiley, 2008. "Estimating the common trend rate of inflation for consumer prices and consumer prices excluding food and energy prices," Finance and Economics Discussion Series 2008-38, Board of Governors of the Federal Reserve System (U.S.).
  3. Robert H. Rasche & John A. Tatom, 1977. "The effects of the new energy regime on economic capacity, production, and prices," Review, Federal Reserve Bank of St. Louis, issue May, pages 2-12.
  4. John A. Tatom & James E. Turley, 1978. "Inflation and taxes: disincentives for capital formation," Review, Federal Reserve Bank of St. Louis, issue Jan, pages 2-8.
  5. Kim, Chang-Jin & Nelson, Charles R & Piger, Jeremy, 2004. "The Less-Volatile U.S. Economy: A Bayesian Investigation of Timing, Breadth, and Potential Explanations," Journal of Business & Economic Statistics, American Statistical Association, vol. 22(1), pages 80-93, January.
  6. Fama, Eugene F, 1981. "Stock Returns, Real Activity, Inflation, and Money," American Economic Review, American Economic Association, vol. 71(4), pages 545-65, September.
  7. Chang-Jin Kim & Charles R. Nelson, 1999. "Has The U.S. Economy Become More Stable? A Bayesian Approach Based On A Markov-Switching Model Of The Business Cycle," The Review of Economics and Statistics, MIT Press, vol. 81(4), pages 608-616, November.
  8. Rasche, Robert H. & Tatom, John A., 1981. "Energy price shocks, aggregate supply and monetary policy: The theory and the international evidence," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 14(1), pages 9-93, January.
  9. Olivier Blanchard & John Simon, 2001. "The Long and Large Decline in U.S. Output Volatility," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 32(1), pages 135-174.
  10. Charles R. Nelson, 2000. "Output fluctuations in the United States: what has changed since the early 1980s? comments," Proceedings, Federal Reserve Bank of San Francisco.
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