Stock Returns and Inflation Redux: An Explanation from Monetary Policy in Advanced and Emerging Markets
IMF Working Papers, August 20, 2021
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- Stock Returns and Inflation Redux: An Explanation from Monetary Policy in Advanced and Emerging Markets
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Bibliographic details
- Authors: Zhongxia Zhang
- Published: August 20, 2021
- Series: IMF Working Papers
- DOI: https://doi.org/10.5089/9781513586755.001
Summary of purpose and approach
- Examines the stock return-inflation relation under different monetary policy regimes and conditions using an expanded dataset of 71 economies.
- Motivated by classical monetary economics prediction: real stock returns are negatively correlated with inflation when monetary policy is countercyclical.
- Extends previous empirical work that mostly focused on a small group of developed countries or a few countries with hyperinflation.
Key empirical findings
- The stock return-inflation relation is partially driven by monetary policy.
- If a country’s monetary authority conducts a more countercyclical monetary policy, the stock return-inflation relation becomes more negative.
- The results differ by monetary policy framework:
- In exchange rate anchor countries, stock markets do not respond to monetary policy cyclicality.
- In inflation targeting countries, stock markets react more strongly to inflation.
- Behavior within inflation targeters matters:
- Markets react to inflation and monetary policy cyclicality when central banks are able to control inflation within their target bands.
- Markets are sensitive to inflation dynamics when inflation is above the announced target bands.
- When monetary policy is constrained by the Zero Lower Bound (ZLB), a structural break is introduced and real stock returns no longer respond to inflation and monetary policy cyclicality.
Subjects and keywords (as classified in the paper)
- Subjects: Central bank policy rate; Emerging and frontier financial markets; Financial institutions; Financial markets; Financial services; Inflation; Inflation targeting; Monetary policy; Prices; Stocks
- Keywords: Central bank policy rate; countercyclical monetary policy; Emerging and frontier financial markets; Global; Inflation; Inflation targeting; inflation targeting country; market perception; monetary policy cyclicality; stock return-inflation relation; Stocks
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- Working Paper