Stock Prices and Inflation

Numerous empirical studies establish that inflation has a negative short-run effect on stock returns but few studies report a positive, long-run Fisher effect for stock returns. Using stock price and goods price data from six industrial countries, our empirical results show that long-run Fisher elasticities of stock prices with respect to goods prices exceed unity and are in the range of 1.04 to 1.65, which tend to support the Fisher effect. We also find that the time path of the response of stock prices to a shock in goods prices exhibits an initial negative response which turns positive over longer horizons. These results help to reconcile previous short-run and long-run empirical evidence on stock returns and inflation. Also, they reveal that stock prices have a long memory with respect to inflation shocks, such that investors should expect stocks to be a good inflation hedge over a long holding period