Identifying the Effects of Nominal and Real Shocks on the S&P 500 Stock Price Index

Abstract

In this paper we investigate the dynamic effects of money supply (‘nominal’) shocks and technology (‘real’) shocks on real stock returns on the basis of the impulse response function of a restricted vector autoregressive model. Appropriate identifying restrictions are derived from the long‐run properties of a structural sticky price model. We find empirical evidence that real (nominal) shocks lead to permanent increases (decreases) in real stock prices and permanent decreases (increases) in the price level. Although the covariance between real returns and inflation is stronger when inflation is caused by real shocks than when inflation is caused by nominal shocks, our results suggest that a considerable part of the negative correlation between real returns and inflation in the long run is due to nominal shocks. Finally, we find that real and nominal components of inflation contain independent information which can be used to explain a higher variance proportion of real stock returns than inflation itself.