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. Differently, non-crisis recessions are associated with rate hikes but no U. Regarding the mechanism, 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. U-shaped monetary rates are also associated with boom-bust dynamics in bank stock returns and profits (in long-run data), and with higher loan defaults, especially for ex-ante riskier borrowers and banks (in post-1995 administrative data for Spain). Overall, results suggest that monetary policy dynamics are crucial for financial stability.