Business Statistic - Assignment 3 PDF

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Term Title of Assignment Individual research projectNames and student IDs of all students Hsu Yu HsienSLocation Class Group SG_G12 (BAFI3182_21s3) Team name (as in Canvas) Lecturer Linh NTH Word Count (Main content without the list of references, cover page, etc.)2469 wordsDeclaration and Statement ...

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Term Title of Assignment Names and student IDs of all students

Individual research project Hsu Yu Hsien S3880502

Location Class Group

SG_G12 (BAFI3182_21s3)

Team name (as in Canvas) Lecturer

Linh NTH

Word Count (Main content without the list of references, 2469 words cover page, etc.)

Declaration and Statement of Authorship 1. I/we hold a copy of this assignment which can be produced if the original is lost/damaged. 2. This assignment is my/our original work and no part of it has been copied from any other student’s work or from any other source except where due acknowledgment is made.

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3. No part of this assignment has been written for me/us by any other person except where such collaboration has been authorized by the academic/teacher concerned and as detailed in the assignment. 4. I/we have not previously submitted this work for any other course/unit. 5. I give permission for my assignment to be scanned for electronic checking of plagiarism. 6. I give permission for a copy of my/our marked work to be retained by the Department for review by external examiners. I/we understand that: Plagiarism is the presentation of the work, idea, or creation of another person as though it is one’s own. It is a form of cheating and is a very serious academic offense that may lead to expulsion from the University. Plagiarized material can be drawn from, and presented in, written, graphic and visual form, including electronic data, and oral presentations. Plagiarism occurs when the origin of the material used is not appropriately cited. Enabling Plagiarism is the act of assisting or allowing another person to plagiarize or to copy one’s work; this is not acceptable and is also subject to penalty. Further information relating to the penalties for plagiarism, which range from a notation on your student file to expulsion from the University, is contained in RMIT Statute 6.1 Student Discipline (see Appendix in Student Guide or consult Turing.)

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THE RELATIONSHIP BETWEEN HIGH INFLATION AND THE STOCK MARKET PRICE Part A: Individual Research Project (1972 words) I.

Abstract: The relationship between inflation and stock market pricing has been a source of fascination

for researchers for decades, and with the emergence of the Covid-19 pandemic and growing inflation, there has been renewed interest in the subject. This research report aims to examine the relationship between high inflation and the stock market price. To find the answer, we will examine the relationship between the US Inflation rate and the US Stock market in 2021-2022 amid the United State worst inflation spike in nearly 40 years. In addition, we also explain how the relationship between the two could change and the fall in stock market price due to the impact of the economic response taken by the US Federal Reserve in an effort to reduce inflation.

II.

Introduction:

In the financial world, there is a long history of research into the influence of inflation on asset prices starting with the so-called ‘Fisher effect’ or ‘The theory of Interest’ by Fisher published in 1930 which advanced the idea that the expected return of an asset should equal to the expected rate of inflation pointing to a positive relationship between inflation and asset prices. However, subsequent theoretical and empirical papers found evidence and demonstrated explanations for a potential negative relationship (Albulescu, Aubin & Goyeau 2017). With many nations now experiencing growing inflation, there has been renewed interest in the subject to examine and predict how a high inflation rate may affect stock market prices in the future. As a result of the US Government and FED economic responses to the largest contraction in the US economy since the Great Depression of the 1930s, which constitutes the largest and longest slump in economic activity in US history caused by the outbreak of the Covid-19 pandemic, the United States is now facing its worst inflation rise in the last 40 years which made the investors ever-increasingly concerned about the stock market's reaction and federal response

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to growing inflation. Many investors are concerned that the US FED's reactionary response of restrictive monetary policy would cause the US stock market to decline in 2022. In order to gain a better understanding of the relationship between high inflation and stock market prices, we will examine the impact of growing inflation rates in the United States and the US FED's reactionary response of restrictive monetary policy on the US stock market in this paper.

III.

Main body: 1. Cause of high inflation? WION (2021) stated on January 13th that the United States is facing its worst inflation

spike in nearly 40 years. According to the US Bureau of Labor Statistics, US inflation increased by 7% between December 2020 and December 2021 as seen in Figure 1, and commodities such as energy, food, transportation, and medicare prices have climbed across the board over the previous year, affecting the lives of US citizens and causing pain to consumers (Aratani, L 2022).

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Figure 1: 12-month percentage change, Consumer Price Index, selected categories, not seasonally adjusted by US Bureau of Labor Statistics, n.d. Figure 1 depicts the largest increase in US inflation in decades, as evidenced by a sharp increase in the percentage change of the Consumer Price Index, which measures what consumers pay for a wide range of goods, at the start of the year 2021, accumulating to the highest increase in US inflation in decades by 7% compared to December 2020. Siegel, R (2021) and Mishra & Mishra (2021) noted that the current spike in US inflation is spurred by a devastating Covid-19 pandemic that has roiled the global economy, disturbing the workforce and supply chains, while government stimulus measures worth trillions of dollars have helped unleash strong demand for commodities, resulting in demand-pull and cost-push inflation.

The rising cost of hiring, transportation, and materials due to shortages caused the shift in the Aggregate Supply (AS) curve to the left from A to A which move the Equilibrium (E) to and price increase from to which constitute cost-push inflation. While the US Government stimulus checks worth trillions of dollars provide money to struggling citizen suffering from the pandemic (AS English 2022), increase the money supply to the economy and encourage consumer demand

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causing demand-pull inflation (Dinh 2020) which shift the Aggregate Demand (AD) curve to the right from A to A and increase the price further from to to more inflation and a New Equilibrium . 2. Empirical literature review According to Singh & G (2020), a study found that the relationship between inflation and stock price in the US evolves over time and is not constant. The relationship between inflation and stock market reaction has been studied for a long time, with many studies pointing to a mixed outcome of either a positive or negative relationship between the two over the years. In the case of the US, they observed that in the 1840s, 1860s, 1930s, and 2011, the relationship is highly positive, but in other time periods it is strongly negative (Singh, Padmakumari & McMillan 2020). The case of a negative relationship between inflation and stock price has been supported by several historical events in the United States, such as the inflation rate in the 2008 subprime mortgage crisis that sparked the Great Recession spiked sharply by 5.6 %, resulting in a 48.54 % fall in the index, and the instance in 2011 when inflation jumped to 3.8 %, causing the index to fall by 12.75 %, as shown in Figure 2s (Drozdovica, J 2021).

Figure 2: US Inflation rate VS Dow Jones Industrial Average by Jekaterina Drozdovica, 2021

3. Impacts on the stock market

Figure 3: The Dow Jones Industrial Average, S&P 500 Index, and Nasdaq Stock Market Composite of the US stock market from January 2021 and January 2022 by WSJ, n.d. Figure 3 on the other hand depicts the current positive relationship between inflation and stock price as the value of the Dow Jones Industrial Average, S&P 500 Index, and Nasdaq Stock Market Composite, which is the three most widely followed US indexes used to measure market performance, rising throughout the year 2021 despite the volatility caused by high inflation, as shown in Figure 1 (Banton, C 2021). The reason for the stock price increase despite the Covid-19 triggering a sharp drop in global economic activity, a collapse in trade, and a severe rise in unemployment that resulted in a contraction in the US economy that was compared to the Great Depression of the 1930s, which constitutes the largest and longest slump in economic activity in US history, was due to the swift Government responses in the form of stimulus checks and the FED's monetary expansionary policy successful in cushioning the economic consequences of the COVID-19 crisis. In 7

comparison to a no-policy benchmark scenario, research shows that monetary expansion resulted in higher output growth and stock market returns, better long-term financing conditions, and a depreciation of the US currency (Feldkircher, Huber & Pfarrhofer 2021). The actions of the US government and the Federal Reserve helped to create an upbeat economic outlook with a strong economic recovery despite inflation concerns, which increased investor expectations about the state of the economy's recovery and encouraged investors to invest in stocks, driving up stock prices (Jackson, A & Schmidt, J 2022). The stock market reaction can differ depending on the condition of the economy for both positive and negative inflation shocks, i.e., the effect of inflation on stock returns is dependent on how investors interpret inflation in different economic states (Singh, Padmakumari & McMillan 2020). 4. The stock market fear in 2022 After many investors considered 2021 to be a good market year, things are about to change as investor fear and nervousness have increased since the US Federal Reserve signaled its intention to combat the pandemic's rampaging inflation by adopting a restrictive monetary policy of selling off Treasury bonds and mortgage-backed securities accumulated during the pandemic, reducing the money supply, and increasing interest rates (Schneider, H & Marte, J 2022). Their anxiety is justified, as many studies have shown that a restrictive monetary policy and higher interest rates reduce stock prices (Bissoon et al. 2016). After the FED signaled its intention to engage in restrictive monetary policy to combat the rampaging US inflation rate, this causes a brief investor panic, resulting in a decline in the Dow Jones Industrial Average, S&P 500 Index, and Nasdaq Stock Market Composite of the US stock market after 3 January 2022. This could signal the start of the stock market's downfall in 2022.

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Figure 4: The effect of decreased Money Supply on the Interest rate When the US FED applied the restrictive monetary policy in 2022 as an attempt to quell the high inflation rate by selling off Treasury bonds and mortgage-backed securities accumulated during the pandemic, reducing the money supply. Then in theory, in the Money Market (Figure 4), it would cause the Money Supply curve (S) to shift to the left from to . A new Equilibrium is created (from to ) and Interest rate increases from to .

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Figure 5: The effect of increased Interest rate on the demand for the stock. Borrowing becomes more expensive for consumers and businesses when interest rates rise. Companies' profit margins may suffer as a result, and equities may become less appealing to investors, while consumer demand is stifled as a result of consumers having less money to spend (Marcos, C.M. & Flitter, E 2021). It would result in the Demand curve (D) shifting to the left from D to resulting in a lower price level (P to ) and lower quantity of stock demanded (Q to ). IV.

Conclusion: In this paper, we examine the relationship between high inflation and stock market prices by

examining the impact of the United States' current high inflation rate on the US stock market and possibly answer the question of how a high inflation rate could affect the stock market.

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In the Empirical literature review, we examined the findings of the theoretical and empirical paper about the relationship between high inflation and stock market prices and found that the relationship between inflation and stock prices in the United States evolves over time, with many studies pointing to a mixed outcome of either a positive or negative relationship between the two over time. It is consistent with the findings of the investigation on the impact of the US stock market's present high inflation rate. The history of the US financial market has shown that in some instance when the inflation rate rise, the stock market fall. In the main body part 1, we investigate what is causing the United States' high inflation rate. The cause is the result of the Covid-19 pandemic disrupting the labor and supply chains, resulting in cost-push inflation, and the US government's trillion-dollar stimulus package stimulating strong consumer demand, resulting in demand-pull inflation. Next in part 3, we investigate the effects of high inflation on the US stock market. We discovered that the relationship between the inflation rate and the stock market price is positive, with evidence indicating that the Dow Jones Industrial Average, S&P 500 Index, and Nasdaq Stock Market Composite, the three most widely followed US indexes used to measure market performance, rise throughout 2021 despite the volatility caused by high inflation. In part 4, we examine how the relationship between the two could change in the future as we research into the investor fear in 2022 of why the US FED’s reactionary restrictive monetary policy in an effort to reduce the US inflation rate could cause the US stock market to decline. However, the result of this part is subjective as it lacks evidence to support that it could happen in the future and the relationship between the two could turn from positive to negative.

V.

References: 1. WION 2021, US inflation at nearly 40-year high | Mismatch in supply & demand fuels

crisis | English News | WION, YouTube, 13 January, viewed 14 January 2022, < https://www.youtube.com/watch?v=TsRzfihTf1Y>. 2. Aratani, L 2022, ‘US inflation jumped 7% in December as prices rise at rates unseen in

decades’,

The

Guardian,

12

January,

viewed

14

January

2022,

<

https://www.theguardian.com/business/2022/jan/12/us-inflation-rate-december-2021>. 11

3. US Bureau of Labor Statistics, n.d., 12-month percentage change, Consumer Price Index,

selected categories, not seasonally adjusted, US Bureau of Labor Statistics, viewed 14 January 2022, . 4. Siegel, R 2021, ‘Prices climbed 6.8% in November compared with last year, largest rise

in nearly four decades, as inflation spreads through economy’, The Washington Post, 10 December,

viewed

14

January

2022,

<

https://www.washingtonpost.com/business/2021/12/10/inflation-november-cpi-fedbiden/>. 5. Mishra, P.K. & Mishra, S.K. 2021, ‘COVID-19 pandemic and stock market reaction: empirical insights from 15 Asian countries’, Transnational corporations review, 2021-0403, Vol.13 (2), p.139-155. 6. AS English 2022, ‘How much were the first, second and third stimulus checks and when

were

they

sent

out?’,

AS,

10

January,

viewed

14

January

2022,

<

https://en.as.com/en/2022/01/11/latest_news/1641861990_313347.html>. 7. Dinh, V 2020, ‘Money supply and inflation impact on economic growth’, Journal of financial economic policy, 2020-04-17, Vol.12 (1), p.121-136. 8. WSJ, n.d., The Dow Jones Industrial Average, S&P 500 Index, and Nasdaq Stock Market

Composite of the US stock market from January 2021 and January 2022, WSJ, viewed 15 January 2022, < https://www.wsj.com/market-data/quotes/index/DJIA/advanced-chart>. 9. Singh, G, Padmakumari, L & McMillan, D 2020, ‘Stock market reaction to inflation announcement in the Indian stock market: A sectoral analysis’, Cogent economics & finance, 2020-01-01, Vol.8 (1), p.1723827. 10. Banton, C 2021, An Introduction to U.S. Stock Market Indexes, Investopedia, viewed 15

January 2022, < https://www.investopedia.com/insights/introduction-to-stock-marketindices/>. 11. Drozdovica, J 2021, US Inflation rate VS Dow Jones Industrial Average, capital.com,

viewed 15 January 2022, < https://capital.com/investing-during-inflation-how-to-protectyour-portfolio>.

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12. Drozdovica, J 2021, Investing during inflation: how to protect your portfolio,

capital.com, viewed 15 January 2022, < https://capital.com/investing-during-inflationhow-to-protect-your-portfolio>. 13. Feldkircher, M, Huber, F & Pfarrhofer, M 2021, ‘Measuring the effectiveness of US monetary policy during the COVID‐19 recession’, Scottish journal of political economy, 2021-07, Vol.68 (3), p.287-297 14. Jackson, A & Schmidt, J 2022, ‘2021 Stock Market Year In Review’, Forbes, 3 January,

viewed 16 January 2022, < https://www.forbes.com/advisor/investing/stock-market-yearin-review-2021/>. 15. Schneider, H & Marte, J 2022, ‘Hawkish Fed signals it may have to raise rates sooner to

fight

inflation’,

Reuters,

6

January,

viewed

16

January

2022,

<

https://www.reuters.com/markets/us/fed-may-need-hike-rates-faster-reduce-balancesheet-quickly-minutes-show-2022-01-05/>. 16. Bissoon, R. , Seetanah, B. , Bhattu-Babajee, R. , Gopy-Ramdhany, N. & Seetah, K. 2016,

‘Monetary Policy Impact on Stock Return: Evidence from Growing Stock Markets’, Theoretical Economics Letters, Vol. 6 No. 5, viewed 16 January 2022, < https://www.scirp.org/journal/paperinformation.aspx?paperid=71380>. 17. Marcos, C.M. & Flitter, E 2021, ‘The Fed’s Moves Pumped Up Stocks. In 2022, It May

Pull

the

Plug.’,

nytimes.com,

31

December,

viewed

16

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2022,

<

https://www.nytimes.com/2021/12/31/business/stock-market-2022.html>. 18. Albulescu, C. T., Aubin, C & Goyeau, D 2017, ‘Stock prices, inflation and inflation uncertainty in the U.S.: testing the long-run relationship considering Dow Jones sector indexes’, Applied economics, 2017-04-15, Vol.49 (18), p.1794-1807.

Part B: Reflection on the Industry Talk: (497 words) The focus of the presentation in the industry talk is to share the experience of our guest lecture Ms. Vy about personal financial planning for the future at our various stages of life.

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The purpose of the discussion, according to Ms.Vy, is to provide common financial scenarios/needs/goals in life, as well as tools and guidance for navigating to our life goals. Ms. Vy then went on to explain several common financial goals that people have throughout their lives, with stages ranging from childhood to high school, university to working, having a family, and finally retirement. Ms.Vy believes that throughout our first 20 years of life, we should master budgeting skills to limit our income expenses at the university level, as this will benefit us greatly in the future. Ms. Vy discusses three basic aspects of money management, the first of which is budgeting, followed by saving, and finally investing. Budgeting entails tracki...