Ownership of Capital in Monetary Economies and the Inflation Tax on Equity

Abstract

Asset pricing models have only partially captured the true inflation risk of equities. The contribution of this paper is to identify and quantify the extra inflation tax on equities that results when ownership of physical capital is separated from nominal ownership of the firm in a production economy with money. We add money to the standard stochastic growth model with production and explicitly distinguish firm ownership of physical capital from household ownership of stock certificates. We prove that the effect of this distinction is to make the value of the firm equal to the firm's capital stock divided by inflation. We then derive the standard asset-pricing conditions from the consumer's Euler equations and show that the effect of inflation on asset returns differs from the effects found in other papers by the addition of a wealth tax. The wealth tax reflects the government's ability to tax the entire future dividend stream at once by taxing the real value of stock certificates, rather than taxing the dividend flow period by period. We show analytically as well as in simulations that the wealth tax effect is significant. This suggests that the presence of the wealth tax is responsible for the greater inflation anxiety in the stock market.