This paper is an attempt to identify the welfare cost of inflation by documenting its impact on the relationship between capital expenditures (investment) undertaken by firms and stock prices. Our arguments take their motivation from prior literature that documents negative effect of inflation on the information content of prices. Friedman (1977), for instance, argues that inflation reduces the information content in prices by increasing the noise. In another related study, Modigliani and Cohn (1979) state that investors suffer from “inflation illusion” and do not incorporate the effect of inflation in their forecasts, thereby causing equity mispricing. Fischer (1981) also maintains that inflation is associated with price variability that is unrelated to fundamentals. We argue that deviations from fundamentals should reduce the information content of stock prices. Above arguments are consistent with Ball and Romer (2003) who develop a model in which inflation reduces informativeness of prices. In their model, decision of consumers to enter into a long-term relationship with sellers depends on a firm’s current price. They argue that firm’s current price is a signal about prices that a firm will charge in future. They show that when inflation causes relative prices to vary, it reduces the information about future prices in current prices. Consequently, current prices become less informative. Tommasi (1996) also reports that inflation degrades the informational content of prices by making aggregate demand shocks unpredictable. 1 He maintains that it is optimal for firms to adjust output less in response to all shocks, including idiosyncratic real demand shocks. The outcome of this misperception is that prices fluctuate more to equate quantity demanded with the less variable quantity supplied. Given that inflation leads to higher variability in prices, it becomes hard for economic agents to detect relevant information from prices (Hsu et al., 2013). 2 Our arguments are also consistent with a strand of literature that argues that stock market agents (that is, analysts and investors) are not able to make accurate forecasts in the presence of high inflation, thereby making stock prices less informative. Basu et al. (2010) show that analysts do not fully incorporate expected inflation information in their forecasts. In another related study, Chordia and Shivakumar (2005) show that, during periods of high inflation, investors do not accurately predict earnings.