Should The Inflation Target be 4.3%?
I’m quite tongue-in-cheek in asking that question, but nevertheless: I present for your delectation what at first blush seems like a revealing bit of chart porn (hat tip: Zero Hedge):
You could flip this upside down and replace “Earning Yield” with “PE ratio.”
The data displays a remarkably regular relationship. Equity investors seem to be most optimistic about future economic (or at least earnings) growth when the inflation rate is 4.3%. (It would be interesting to see: did this relationship hold, albeit with the inevitable noise from smaller samples, in shorter sub-periods — and if so, which sub-periods? In particular curious: did it hold equally pre- and post-1971?)
Can we draw any conclusion from this? i.e.:
• Market conditions that are most conducive to economic growth are revealed by a 4.3% inflation rate.
• Equity investors display the most “irrational exuberance” when the inflation rate is 4.3%.
I’d love to hear whether Market Monetarists and MMTers think this has any useful import.
Cross-posted at Asymptosis.
Hey Steve. What you’ve done is show us an interesting correlation-the key is to actually figure out the meaningful causation story. One guess is that 4.3% is not the cause of a bull market but an effect.
A stronger economy tends to have a higher inflation rate than a bust economy.
Initial thought: meaningless; confuses nominal return with real return.
Difference in earning yield between 2% and 4.3% inflation is negligible, but at 2% inflation much less of your principle is being eroded.
I’d sooner argue the optimal inflation rate is lower than 2% based on this.
Exactly right. See the wording of my first bullet point.