Beliefs about how inflation impacts asset returns vary widely across investors, who are often overly optimistic. Information about past returns during periods of high inflation causes investors to update their beliefs, which feeds into their return expectations and subsequent trading behavior.

Surprise changes in US monetary policy rates directly affect asset prices, with a 100-basis point surprise cut resulting in a 30-basis point increase in the ratio of stock prices over 5 days; this effect grows after the initial announcement because higher-frequency strategies likely underestimate the effects of policy transmission.

Firms often keep their nominal discount rates constant even in the face of changing inflation expectations. Increases in expected inflation therefore lower firms’ real discount rates and raise real investment.