NCPA - National Center for Policy Analysis

Stock Market Rise Doesn't Herald Inflation

July 13, 1998

Some economists believe the Federal Reserve Board's Federal Open Market Committee (FOMC), which determines monetary policy, is keeping interest rates higher than necessary. Economist Brian Wesbury notes that when adjusted for inflation the fed funds rate is now at its highest level in over nine years, and the lack of an easy monetary policy risks a recession.

Other economists believe inflation lies just over the horizon, and the Fed should keep money tight and raise interest rates if necessary to forestall inflation. "The economy today seems to be nearing the classic stage of overheating that precedes an acceleration of inflation," writes Rob Norton in Fortune Magazine.

The inflation "hawks" are concerned about the rise of the stock market. They worry this may be the sign of an inflationary bubble that could easily burst with a stock market crash. They also worry that rising stock wealth may encourage consumers to buy more than their incomes would ordinarily allow, thus bidding up prices at the retail level.

However, the relationship between stock prices and inflation is tenuous at best (see figure). The reason is that purchases of stock are a form of saving, not consumption. Since the Consumer Price Index reflects only changes in prices for consumption goods, rising stock prices cannot be an indicator of inflation. In fact, many economists believe the main reason stocks have risen is precisely because inflation has fallen.

Source: Bruce Bartlett, senior fellow, National Center for Policy Analysis, July 13, 1998.


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