Empirical Analysis Impact of Inflation Dynamics on Financial Market Performance

Abstract

In 2023, in response to inflation, the Federal Reserve implemented an unprecedented strategy of rapid interest rate hikes. This approach had a significant impact on the financial market, causing extensive fluctuations, predominantly downward, especially in sectors such as the banking industry that have a strong correlation with the financial market. Therefore, understanding how inflation influences financial market performance is a crucial economic matter. This study utilizes data from the Consumer Price Index (CPI), Nasdaq index, and S&P500 index spanning from 2000 to 2023. Through correlation analysis and benchmark regression, we assess the impact of inflation on the financial market and provide policy recommendations. Based on the model analysis, this study finds that the CPI generally has a positive impact on the financial market. To examine the varying impacts of the CPI on the financial market at different time periods, this paper employs temporal heterogeneity analysis. This method evaluates the shifts in the influence of the CPI on the financial market by dividing periods before and after significant events. The findings suggest that the CPI had a negative correlation with the Nasdaq index prior to the August 2007 financial crisis. However, after this crisis and leading up to the emergence of COVID-19 in January 2020, there was a positive correlation between the CPI and the financial market. Yet, following the onset of the COVID-19 pandemic, there was not a substantial correlation between the CPI and the market index.