In the case of unexpected inflation, the interpretation of their results is quite intuitive: news on inflation is correlated with news on future earnings prospects and/or required returns. For example, an unexpected rise in inflation may raise the risk of countercyclical monetary policy, which is likely to reduce expected real earnings growth and/or raise investors’ discount rates. Indeed, Thorbecke (1997) provides compelling evidence that tighter monetary policy has a significant negative effect on stock prices, though whether this reflects an earnings channel or discount rate channel remains unresolved. .
