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Emeritus Professor of Finance
Nominal Return; Stock Market; Inflation; Monetary Policy; Productivity Shock; Fiscal Theory; JEL Classification: E12; E13; E17; E31; E44; E62; G12; G17
The authors construct recursive solutions for, and study the properties of the dynamic equilibrium of an economy with three types of agents: (i) household/investors who supply labor with a finite elasticity, consume a large variety of goods that are not perfect substitutes and trade government bonds; (ii) firms that produce those varieties of goods, receive productivity shocks and set prices in a Calvo manner; (iii) a government that collects an income-driven fiscal surplus and acts mechanically, buying and selling bonds in accordance with a Taylor policy rule based on expected inflation.In this setting, the authors show that stock market returns are much less than one-for-one related to inflation over a 1-year holding period, which means that stock securities have a strong nominal character. The authors also show that their nominal character diminishes as the length of the stock-holding period increases, in accordance with empirical evidence.