The Net Present Value of Stabilizing Inflation

When countries attempt to stabilize annual inflation rates that are greater than 40 percent, the domestic stock market appreciates by 24 percent on average. The present value of the long-run benefits to shareholders of reducing high inflation outweighs the present value of the short-run costs. In contrast, the average market response is economically weak and statistically insignificant if the pre-stabilization inflation rate is less than 40 percent. Stock market responses also help predict the change in inflation and output in the year following stabilization efforts. This additional result indicates that the stock market evidence for the 81 inflation stabilization episodes studied here is not spurious. Assistant Professor of Economics: Stanford University, Graduate School of Business; Stanford, CA 94305-5015; (650) 723-0905; [email protected]. I am grateful to Steve Buser and Paul Romer for detailed comments on earlier drafts. I also thank Andrew Karolyi, Tom Sargent, René Stulz, Ewart Thomas, and Ingrid Werner for helpful discussions. Richard Clarida, Héléne Rey, seminar participants at Ohio State, the IMF, London Business School, the NBER, Stanford and the World Bank also provided helpful feedback. Serkan Arslanap, Joanna Campbell, Begna Gebreyes, Chad Milner, Nora Richardson, and Laura Veldkamp provided stellar research assistance. Finally, I thank the Dice Center for Financial Economics at Ohio State University for providing a stimulating research environment during the Summer of 2000. All remaining errors are my own.