Real Asset Returns and Components of Inflation: A Structural VAR Analysis

We shed new light on the negative relationship between real stock returns or real interestrates and (i) ex post inflation, (ii) expected inflation, (iii) unexpected inflation and (iv)changes in expected inflation. Using the structural vector autoregression methodology, wepropose a decomposition of those series into economically interpretable components drivenby aggregate supply, real demand and money market shocks. Our empirical results supportFama’s ’proxy hypothesis’ and the predictions of several general equilibrium models. Concerningthe negative relation between the real rate of interest and inflation, we find thatthe Mundell-Tobin model and the explanation of Fama and Gibbons (1982) are not competitors:both add insight in their own way about the reasons for the negative correlationbetween those variables. However, the importance of the latter explanation has decreasedsince the 1980’s.