- February 1, 2012: Vol. 6, Number 2

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Why Is Inflation So Confusing?: Inflation Is Rarely Good News, and Investors Can Get to Grips with It Only if They Understand It Better

by Simon Martin

In recent times, it’s become pretty difficult to have a conversation about economics without the discussion turning to the risk of inflation and the ensuing debate about the potential inflation-hedging characteristics of real estate assets. This debate always seems to end up with the inadequate conclusion: at best, the academic analysis can only demonstrate a mathematically weak hedge, even when intuition and behaviour suggests that the hedge is more powerful in practice.

We know that inflation expectations are one of the key transmission mechanisms between the real economy and capital markets. Inflation drives interest rates, discount rates and, as a result, asset values. This is clearly seen in both equity and bond markets, as rising inflation expectations have always been bad for the values of stocks and bonds. However, the same cannot be same for property. Real estate cashflows have a close relationship with nominal GDP and should have a close relationship

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