Inflation, Monetary Policy And Stock Market Conditions: Quantitative Evidence From A Hybrid Latent-Variable VAR

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Executive Summary

This paper examines the association between inflation, monetary policy and U.S. stock market conditions during the second half of the 20th century. The authors use a latent variable VAR to estimate the impact of inflation and other macroeconomic shocks on a latent index of stock market conditions. The objective is to investigate the extent to which various shocks contribute to changes in market conditions, above and beyond their direct effects on real stock prices. They find that disinflation shocks promote market booms and inflation shocks contribute to busts. Further, they find that inflation shocks can explain more of the variation in real stock prices when stock market conditions are taken into account.

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