Financial Market Inflation Perception and Firm Investments

Abstract

We estimate a measure of inflation perception based on the difference in inflation sensitivities across industry-based equity portfolios. Financial market inflation perception reflects how investors believe inflation will impact future earnings. We show that heightened inflation perception reduces future industrial production and output through firm investments. However, professional forecasters do not consider inflation perceptions when forming expectations about future economic activity. Finally, we discuss policy implications of the stabilizing effect that inflation perception has on the business cycle.

Keywords: Industry equity returns, inflation, investments, business cycle, policy actions

JEL Classification: G12, G20, G23