This paper offers a novel post-Keynesian theory, in a stock-flow consistent framework, to understand equity returns and their links with economic growth and consumption decisions from a long-run perspective. The main features of such a theory can be summarised as follows. First, there is a negative relationship between Tobin’s q and economic growth. Second, the effect of economic growth on dividend yields and earnings growth is positive, but its effect on the growth in the number of shares is negative (i.e. a ‘dilution effect’), which makes the relationship between equity returns and economic growth undetermined a priori. Third, consumption decisions emerge as crucial drivers for shareholder profitability in the long-run, being such a result very close to Kalecki’s theory of profits, but now applied to financial markets. And fourth, in the post-Keynesian theory the equity yield is determined by aggregate demand, and no theory of risk is needed. Finally, the post-Keynesian theory will be compared against the mainstream financial theory, which features the famous risk-return nexus where asset returns are given by the volatility of the asset with respect to consumption. It will be claimed that the use of risk for determining equity returns at the macroeconomic level is problematic, and that depending on the risk definition assumed, the risk-return relationship can be either positive or negative – being thus such a nexus of little theoretical significance and posing serious problems for mainstream finance.
Keywords: equity yield, dividend yield, Tobin’s q, post-Keynesian macroeconomic theory, Kaleckian growth models, stock-flow consistent models, mainstream finance
JEL classification: E12: General Aggregative Models: Keynes; Keynesian; Post-Keynesian E22: Investment; Capital; Intangible Capital; Capacity E44: Financial Markets and the Macroeconomy G10: General Financial Markets: General (includes Measurement and Data) O42: Monetary Growth Models
Download: Working Paper PKWP1613