Stock Prices, 1900-1995: The Real and Nominal Story

Abstract

Prompted by the inflation-adjusted Dow Jones Industrials Average setting its first record high in almost thirty years in 1995, this paper studies the impact of inflation on nominal and real stock prices from a theoretical, historical, and empirical perspective. While stocks are an excellent longterm hedge against inflation, nominal stock prices stagnate and real stock prices fall during a period of rapid inflation. Both nominal and real stockprices then go through a catch-up phase during the subsequent disinflation period. The history for this century is consistent with this pattern. Regression analysis between real and nominal stock prices as the dependent variables and inflation as the independent variable shows statistically significant evidence that (a) nominal stock returns are positively related to inflation while real stock returns are not; and (b) both nominal and real stock returns are negatively related to accelerations of inflation and positively related to decelerations.