A healthy economy grows at a sustainable rate, and since inflation is a typical by-product of economic growth, some degree of inflation is a mark of a healthy economy. A moderate amount can also be good for the stockmarket: reasonably higher prices can lead to higher earnings for companies, and investors tend to pay more for stocks that are demonstrating earnings growth.
This is borne out by our research. We found that for the S&P 500 Index – which is considered broadly representative of stocks as a whole – the highest equity valuations were observed for inflation rates of between 2% and 4%. But when inflation is beyond 5% or so, we tend to see lower earnings and lower levels of consumption overall.