The Impact of Inflation Targeting Regime on the Relationship between Stock Returns and Inflation: International Evidence

Document Type

Conference Presentation

Conference Title

International Atlantic Economic Society Conference

Location

Boston, MA

Conference Dates

October 8-11, 2009

Date of Presentation

10-11-2009

Abstract

21 industrialized and non-industrialized countries have adopted inflation targeting monetary policy since 1990 to combat persistently high inflation rate. This policy accords either the government and/or the central bank the authority to assign an explicit numerical target for the inflation rate and implement an appropriate monetary policy to achieve its goal. The proponents of this policy have long claimed that inflation targeting would not only diminish the level and volatility of inflation rate, but also increase both the transparency and accountability of the monetary policy. Given there has been a well documented, negative relationship between stock returns and inflation rate for both the United States and other countries during the post-Korean War period, this study investigates whether implementation of inflation targeting strategy will affect the strength of such relationship. This study posits a hypothesis that, in an economy where inflation targeting is adopted as a new monetary policy strategy, inflation rate should have more significant and negative impact on stock returns. Both monthly and quarterly data for Australia, Canada, Chile, Israel, New Zealand, Sweden and United Kingdom have been employed in this study. The primary source of data for this study is the International Financial Statistics databasse published by the International Monetary Fund (IMF). For each country, data from 10 years prior to the formal adoption of inflation targeting regime to about 10 years after the adoption of the regime are employed. The results are found to be somewhat mixed. A change in inflation rate relative to its target rate has had a negative and statistically significant impact on real monthly stock returns for only Chile, Israel and Sweden, and on real quarterly stock returns for only Chile and Israel, and this relationship has strengthened for these countries after formal adoption of inflation targeting monetary policy.

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