Is Disinflation Good for Growth?

By Peter Blair Henry
2000| Working Paper No. 1657

When countries attempt to stabilize annual inflation rates greater than 40 percent, the domestic stock market appreciates by 24 percent on average. Therefore, the long-run growth benefit of reducing high inflation outweighs the short-run cost. In contrast, the average market response is economically weak and statistically insignificant if the per-stabilization inflation rate is less than 40 percent. Hence, the net growth benefit of reducing moderate inflation is negligible. The first result seems more consistent with the rational expectations view of disinflation than with the traditional view. The second result appears more consistent with the traditional view than with rational expectations. Together, the results suggest that neither view sufficiently captures the real effects of disinflation across all ranges of initial inflation. The stock market responses also help predict the change inflation and output in the following year. This additional result indicates that the stock market evidence for the 81 disinflation episodes studied here is not spurious.