Deflation and Stock Prices
26 Pages Posted: 27 Sep 2016
Date Written: September 19, 2016
Abstract
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