The Dual Effect of Inflation on Stock Price

Inflationis an important macroeconomic factor affecting the stock market price. Theinfluence of this factor on the trend of stock market is complex. It cannotonly stimulate the stock market, but also suppresses the stock market.Inflation is mainly due to excessive increase in the money supply. The moneysupply is generally proportional to the stock price, that is, the increase ofthe money supply will rise the stock price; on the contrary, the decrease ofthe money supply makes the stock price fall. But under some specialcircumstances, there will be reverse trend.

Therelationship between money supply and stock price has three forms:

①The increase of money supply, on the one hand, cansupport production and prices and prevent the decline of profits; on the otherhand, the increase in demand for stocks will be an important factor in stoppingthe decline of stock prices.

②The increase of money supply causes the price of social goods to rise,andthe sales of joint-stock companies increase accordingly. As a result, thedividend represented by money quantity (i.e. the nominal income of stocks)rises to a certain extent, which makes the demand for stocks increase and thestock price correspondingly goes up.

③The increase of money supply will lead to inflation.Inflation often leads to false market prosperity, and eventually leads to thefalse appearance of rising profits of enterprises. People tend to invest moneyin precious metals, real estate and short-term securities due to the awarenessof maintaining value. As a result, the demand for stocks will also increase andthe stock price will climb accordingly.

Itcan be seen from the above that the increase or decrease of the money supply isone of the important reasons affecting the stock price. With the increase ofthe money supply, the expanded social purchasing power will be invested in thestock, thus raising the stock price. On the contrary, if the money supplydecreases and the social purchasing power decreases, the investment will reduceand the unemployment rate will increase. Finally, the stock price willcertainly be affected. This is the main aspect of the problem.

However,when inflation reaches a certain extent, or even more than double digits, itwill drive interest rates up, thus causing stock prices to fall, which isanother aspect of its effect on stock prices.

In a word, the trend of stock market is consistentwith that of inflation when the stimulation effect is greater, and the trend ofstock market is opposite to that of inflation when the effect of repression isgreater.