Monetary Policy, Inflation, and Crises: New Evidence from History and Administrative Data


We show that a U-shaped monetary rate path increases banking crisis risk, via credit and asset price cycles, analyzing 17 countries over 150 years. Monetary rate hikes (raw or instrumented using the international finance's trilemma) materially increase crisis risk, but only if rates were previously cut (or low) for long. Consistently, rate cuts in the first half of the U increase the likelihood of vulnerable "red zones" of high credit and asset prices, while subsequent rate hikes within "red zones" tend to trigger crises. We find similar dynamics for bank stock returns and profits. In post-1995 administrative data for Spain, a U-shaped rate path increases loan defaults, especially for ex-ante riskier borrowers and banks.