Abstract:
The existing literature on the theoretical relationship between the rate of inflation
and real stock prices in an economy has shown varied predictions about the long
run effects of inflation on real stock prices. In this paper, we present some time series
evidence on this issue using South African data, by applying the structural bivariate vector
autoregressive (VAR) methodology proposed by King and Watson (1997). Our empirical
results provide considerable support of the view that, in the long run real stock prices are
invariant to permanent changes in the rate of inflation. The impulse responses reveal a
positive real stock price response to a permanent inflation shock in the long run, indicating
that any deviations in short run real stock prices will be corrected towards the long
run value. It is therefore concluded that inflation does not lower the real value of stocks
in South Africa, at least in the long run.
