Usually when inflation rises the stock market rises with it. The second point i want bring your attention to before i ask my question is when there are stimulus measure enacted by the government, thereby increasing the government deficit and there being a corollary between government spending and asset prices.

If there is a scenario where the economy enters a period of deflation, does this necessarily mean that asset prices will depress? Or could this be avoided where asset prices stay the same or keep rising ?

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    $\begingroup$ Your statements about there hardly being any exceptions to inflation rising implying stock prices going up is controversial. The first paragraph should probably be deleted, as it is a distraction unrelated to the question. Also, the phrase “enters a period of deflationary cycle” does not make sense. “Entering a period of deflation” might be what you mean to say, but that is also a vague statement. $\endgroup$ Apr 17, 2020 at 19:40
  • $\begingroup$ @BrianRomanchuk: "when inflation rises the stock market rises with it". I think in nominal terms that's probably not very controversial. In real terms, though... The same unclarity issue plagues the 2nd part of the q here. $\endgroup$ Apr 18, 2020 at 2:23
  • $\begingroup$ In re 1st para nber.org/chapters/c11335.pdf "when the inflation rate is steady, share prices rise in proportion to the price level to maintain a constant ratio of share prices to real earnings. In contrast, an increase in the expected future rate of inflation causes a concurrent fall in the ratio of share prices to current earnings. Although share prices then rise from this lower level at the higher rate of inflation, the ratio of share prices to real earnings is permanently lower." [cont'] $\endgroup$ Apr 18, 2020 at 4:00
  • $\begingroup$ "This permanent reduction in the price-earnings ratio occurs because, under prevailing tax rules, inflation raises the effective tax rate on corporate source income" $\endgroup$ Apr 18, 2020 at 4:02
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    $\begingroup$ @Fizz I believe there was a decent bear market in the 1970s - when inflation was rising. Saying that fair value should rise is not the same thing as stock prices actually rising. Given the imprecision of the statement, someone with access to stock price data could find plenty of counter-examples. The poster has one example of an alleged law of market pricing. $\endgroup$ Apr 18, 2020 at 11:14

1 Answer 1


One would need access to stock price index data to make definitive statements. There are probably studies doing such analysis. However, I will make some rather safe generalised comments.

Firstly, we should expect differences in behaviour between the gold standard era and the present, as well as between developed and developing markets.

My expertise is with floating currency, developed countries. And the following statements appear safe to say.

  • Other than Japan, there has been no extended period of falling CPI (“deflation”) outside of recessions/global crises in the floating currency era. Pre-2020, that deflation was mainly due to falling oil prices, core CPI remained positive.
  • Stock markets tend to fall in recessions, for many reasons. Most modern recessions have been associated with financial crises, and leveraged investors needed to cover positions. This means that stock prices can be lower than fundamentals.
  • The deflation in Japan was extremely mild, and I would guess that there were some periods of rising stock prices (although the Japanese stock market was in a secular bear market after the bubble pop in the early 1990s) coinciding with deflation. Someone with access to Japanese financial data would have to verify what happaned.

As such, we have no real guidance for what sort of “deflation” can happen in a floating currency sovereign. However, it is very hard to see what significant difference a deflation of -1% has versus an inflation of 1% for equity valuations (with those rates being similar to historical post-1990s experience). Stocks could rise and fall based on the moods of stock investors. The difference in expected nominal growth rates can easily be counter-acted by lower discount rates.


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