Since 24th November 2011, the FTSE 100 has increased by 14.6%, the S&P 500 by 21.1%, the DAX by 30.2% and the CAC 40 by 25.1%. Why has there been a rally in equity markets over the past four months? There are several possibilities ranging from an improved outlook for the US economy (the equity market is usually an economic bellwether), further quantitative easing by central banks, the ECB's huge liquidity injection into the European banking system, and an easing of the severity of the European debt crisis.
David Glasner has posted an interesting explanation for the rally over at his Blog - click here. He basically suggests that the market rally is due to an increase in inflationary expectations, which has resulted in a fall in real interest rates and a rise in stock prices. As a UCLA graduate, Glasner was no doubt influenced by Alchian and Kessel's famous paper entitled "The Effects of Inflation". In this paper, Alchian and Kessel discuss how inflation affects real interest rates, bond prices, and the price of real assets as well as how inflation redistributes wealth from net monetary creditors to net monetary debtors.
