Deflation and Stock Prices
26 Pages Posted: 27 Sep 2016
Date Written: September 19, 2016
While the literature on inflation and stock prices is plentiful, there is little literature on deflation and stock prices. This paper explores the empirical data and makes a theoretical analysis of the likely impact on stock prices when expectations changes from inflation to deflation. The main conclusions are: 1: The 1930s was a statistical outlier and not representative for a deflationary period; 2: Deflation does not seem to create recessions, causality goes the other way; 3: Real stock returns are lowest in high inflation environments, while real stock returns are positive and around average in the periods leading up to and following the onset of deflation; 4: The empirical evidence and the theoretical exercises are mixed as regards the impact on P/E ratios from deflation. When moving from low inflation to mild deflation, P/E is virtually unchanged; and 5: Deflation illusion might explain the surprisingly small decline in P/E ratios in the face of deflation.
Keywords: Deflation, deflation illusion, stock prices, price-to-earnings ratio
JEL Classification: E31, G12
Suggested Citation: Suggested Citation