The influence of equity market movements on inflation : insights from the US and China

Abstract

This thesis investigates the relationship between real stock market returns and inflation in the United States and China, analyzing their dynamics over various time horizons. Given the central role of inflation in monetary policy and its importance on financial markets, understanding how stock returns influence inflation could bring valuable insights for policymakers, investors, and economists.

The study employs a Vector Autoregression (VAR) model to examine the causal mechanisms linking stock market movements and inflation, incorporating the Phillips curve in inflation modeling. The empirical analysis utilizes time-series data from the Wilshire 5000 index for the US and the Shanghai Stock Exchange (SSE) Composite Index for China, alongside inflation data from official sources.

Results indicate that while short-term stock market fluctuations exhibit minimal impact on inflation, a significant relationship emerges over longer time horizons. The findings suggest that investor expectations, behavioral biases, and differences in market structures influence how stock returns translate into inflationary pressures. In the US, stock returns initially have a negative impact on inflation, followed by a delayed positive effect, suggesting irrational expectations. In contrast, China’s financial market dynamics display a more traditional relationship, with an initial positive impact, reflecting structural differences in financial market participation.