How to Hedge Against Inflation: Use Equities?
- By Sam van de Schootbrugge
- 6 min read
Many have documented that equities are poor inflation hedges in the short term. That is, as inflation rises, the growth in real stock returns falls. In 1979, Franco Modigliani and Richard Cohn put it down to ‘money illusion’, but several alternative hypotheses exist. A new IMF working paper explores how a country’s monetary policy regime affects the stock return-inflation relationship. It finds:
If a country pursues more countercyclical monetary policy, i.e., ‘leans more heavily against the wind’, stock markets react more negatively to inflation, especially in advanced economies.
The negative relation between stock returns and inflation is particularly noticeable under inflation-targeting regimes, while stock returns pay no attention to inflation under exchange rate anchoring.
When the zero lower bound (ZLB) constrains the policy rate, markets generally disregard inflation and monetary policy cyclicality, i.e., the stock return-inflation relationship is no longer significant.
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