Are common stocks a good hedge against inflation? Evidence from the Pacific-Rim countries

Abstract

We explore whether the observed stock return-inflation relations in the 11 Pacific-Rim countries for the sample period of l 970-1997 can be explained by the interaction between supply and demand disturbances. We find striking similarities in the real stock return-inflation relationship among most of the countries, although they are substantially different in other respects. First, 10 countries exhibit a negative relationship between real stock returns and inflation, which implies that common stocks were not a good hedge against inflation in these countries. Malaysia is the only country that exhibits a positive relation between stock returns and inflation. Second, for nine countries, supply ( e.g., real output) disturbances drive a negative stock return-inflation relation while demand( e.g. monetary) disturbances yield a positive stock return-inflation relation. In addition, supply components appear to be relatively more important than demand disturbances for these countries during the sample period, and as a result the observed relation between stock returns and inflation is negative. Third, neither the tax hypothesis nor the monetary regime hypothesis seems to be easily compatible with diverse experiences of the Pacific-Rim countries.