20210819-IMF-Stock_Returns_and_Inflation_Redux_An_Explanation_from_Monetary_Policy_in_Advanced_and_Emerging_Markets_59页_1mb

Stock Returns and Inflation: Role of Monetary Policy

Introduction

This paper analyzes the relationship between real stock returns and inflation across 71 advanced and emerging economies. Using a panel dataset, it examines how monetary policy regimes influence this dynamic, addressing gaps in previous studies focused on a small set of developed countries.

Main Findings

• Stock-Inflation Relationship: Real stock returns are negatively correlated with inflation, with the strength influenced by monetary policy. More countercyclical policies amplify this negative response.
• Monetary Policy Frameworks:
  • Exchange rate anchor countries show minimal stock market response to policy cyclicality.
  • Inflation targeting countries exhibit stronger stock market sensitivity to inflation, especially when inflation exceeds target bands.
  • Emerging markets show weaker responses due to procyclical policies and lower central bank credibility compared to advanced markets.
• Zero Lower Bound (ZLB) Constraint: When monetary policy is restricted by the ZLB, the stock-inflation relationship breaks down, indicating reduced sensitivity to inflation changes.

Policy Implications

Central banks should consider how their policy stance affects market perceptions and stock returns. Improving communication and credibility can shape market reactions to inflation shocks. Policymakers in emerging markets should account for country-specific factors when adopting advanced practices.

Conclusion

The study highlights that monetary policy cyclicality, framework choice, and policy constraints significantly shape the stock-inflation relationship. These insights provide guidance for central banks to manage market expectations and promote financial stability.