Working Paper

Do stock prices follow interest rates or inflation?

Abstract: Market analysts often forecast changes in stock prices by comparing earnings-price ratios on stocks to nominal interest rates. This paper shows that stock prices have followed inflation more closely than interest rates over the last thirty years. This result has implications for recent stock valuations, because the spread between nominal interest rates and inflation has recently been above historic averages. That is, stock prices appear more overvalued when the earnings-price ratio is compared to nominal interest rates than when the earnings-price ratio is compared to inflation. Our result also helps explain the behavior of stock prices during the 1970s.

Keywords: Inflation (Finance); Interest rates; Stock - Prices;

Bibliographic Information

Provider: Federal Reserve Bank of Kansas City

Part of Series: Research Working Paper

Publication Date: 1996

Number: 96-13