The owner of a portfolio of common stocks will lose from unanticipated inflation in the same way as the owner of a portfolio of government bonds will.
True or False?
The correct answer is false. Only asset holders whose assets are fixed in nominal terms necessarily lose from unanticipated inflation. When inflation occurs, the flow of nominal income from common stock holdings tends to rise along with the price level as does the market value of the shares themselves. Although the real value of common stocks is not necessarily unaffected by inflation, stocks are certainly a better hedge against unanticipated inflation than are bonds. In a sense, stocks are "naturally" indexed.
It is useful to think of common stocks as perpetuities that yield a future expected flow of income equivalent to some constant amount R. The present value of these "earnings" is thus
PV = R ⁄ r
If R increases in proportion to the rise in the price level PV will do the same at unchanged r . The end-of-period realized real interest rate and the interest rate used to calculate the beginning-of-period present value will therefore be the same.
Physical capital assets and land are the same as shares in the firms that own them in that their nominal earnings, and hence their nominal values, tend to rise and fall with the general price level. They are good assets to be holding when unanticipated inflation occurs, but poor assets to be holding (as compared to non-indexed bonds) when there is unanticipated deflation.