Does Monetary Policy Affect Stock Prices and Treasury Yields? An Error Correction and Simultaneous Equation Approach

The regression results also imply that expected inflation has a substantial effect on expected long-run real equity returns. In other words, in addition to the negative effect on stock prices associated with its effect on expected earnings, higher expected inflation also raises long- run required returns. Roughly speaking, a one percentage point increase in expected inflation increases required long-run real stock returns about a percentage point; equivalently, it reduces the current price of stocks about 20 percent. At the same time, the analysis suggests that the component of expected stock returns associated with expected inflation is closely related to the components of expected returns associated...