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  5. Banking in an Inflationary Environment
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Banking in an Inflationary Environment

Paper Session

Saturday, Jan. 4, 2025 8:00 AM - 10:00 AM (PST)

Parc 55, Cyril Magnin 1
Hosted By: American Economic Association
  • Chair: Philip Lane, European Central Bank

Loose Monetary Policy and Financial Instability

Maximilian Grimm
,
University of Bonn
Oscar Jorda
,
University of California-Davis
Moritz Schularick
,
Kiel Institute for the World Economy
Alan M. Taylor
,
University of California-Davis

Abstract

Do periods of persistently loose monetary policy increase financial fragility and the likelihood of a financial crisis? This is a central question for policymakers, yet the literature does not provide systematic empirical evidence about this link at the aggregate level. In this paper we fill this gap by analyzing long-run historical data. We find that when the stance of monetary policy is accommodative over an extended period, the likelihood of financial turmoil down the road increases considerably. We investigate the causal pathways that lead to this result and argue that credit creation and asset price overheating are important intermediating channels.

Banking When Inflation Surges: Headwinds or Tailwinds?

Katharina Bergant
,
International Monetary Fund
Divya Kirti
,
International Monetary Fund
Rui Mano
,
International Monetary Fund
Mai Hakamada
,
International Monetary Fund

Abstract

The recent rise of inflation globally and the subsequent monetary policy response bring to the fore questions on the resilience of banking operations in the current environment. How does inflation affect bank profits? And are such effects distinct from those of interest rates? Beyond conceptually framing these questions, this note empirically investigates the issue using data on over 6,500 banks operating in 59 AEs and EMDEs over nearly three decades. It finds that: (i) overall bank profitability is generally insensitive to inflation, but inflation affects sub-components of bank profits; (ii) net interest and net non-interest profits are much less exposed to inflation than gross income and expenses on their own; (iii) both direct and indirect effects of inflation play a role, as confirmed in a panel of banks within the Euro area; and (iv) gross exposures to inflation vary widely across countries, but net exposures are small everywhere.

Do Banks Gain from Inflation? Evidence from Inflation Surprises

Nathan Converse
,
Federal Reserve Board
Anil Jain
,
Federal Reserve Board

Abstract

Using a high-frequency event study, we examine the effect of inflation on bank profitability by analyzing banks’ risk-adjusted stock returns in a narrow time-window around U.S. consumer price inflation releases. We find that bank stock prices outperform the broader stock market on higher-than-expected consumer price inflation prints. Moreover, we find that this relationship is substantially larger during periods of high inflation. We find evidence that the key channel for this outperformance of bank stock prices is through higher-than-expected inflation causing interest rates to rise, and consequently, bank profits to rise due to incomplete passthrough of higher rates into bank deposit rates.

Discussant(s)
Diana Bonfim
,
Banco de Portugal and Católica Lisbon
Pascal Paul
,
Federal Reserve Bank of San Francisco
Deniz Igan
,
Bank for International Settlements
JEL Classifications
  • G2 - Financial Institutions and Services
  • E4 - Money and Interest Rates