The Long-Run Relationship between Inflation and Real Stock Prices

In this paper, we use recent developments in the testing of long-run neutrality propositions to measure the long-run response of real stock prices to a permanent inflation shock for 16 individual industrialized countries. The estimation results provide considerable support for long-run inflation neutrality with respect to real stock prices. Ranges of plausible identifying parameter values are also consistent with a positive long-run real stock price response to a permanent inflation shock. There is little plausible evidence for a negative long-run real stock price response to a permanent inflation shock. Overall, our results indicate that inflation does not erode the long-run real value of stocks