By: DanielXX

I saw this in a journal and thought it provided a good overview of how inflation relates to the economy as well as the wealth effect of the stock market. If you refer to the picture, inflation has an effect on both interest rates and individuals' wages which in turn determine spending power (via borrowing and disposable income respectively). Spending power is also dependent on the wealth effect which emanates from asset appreciation (via stock market). But note that what's important to business profitability ("corporate profits") and further investment ("capital spending") is real consumer spending which is the actual tangible demand (adjusted for inflation). Corporate profits provides the basis for employment which underpins consumer borrowing and individuals' wages, completing the loop. The above was extracted from a journal whose name I've forgotten (sorry). Source: My Thoughts On Stock Investing