The causal effect of inflation on financial stability, evidence from history

Ugo Albertazzi, Hooft, James ’t and Lucas Ter Steege

No 3108, Working Paper Series from European Central Bank

Abstract: In contrast to the conventional Fisherian view that inflation reduces real debt positions, we show that significant increases in inflation are strongly associated with financial crises. In the spirit of Jordà et al. (2020), countries with free and fixed ex-change rates can be compared to difference out the confounding reaction of monetary policy. Across a dataset of 18 advanced economies over 151 years, we show that the impact of inflation extends beyond its indirect effect via monetary policy. To further corroborate causality, we instrument inflation with oil supply shocks, finding that a 1pp rise in inflation doubles the probability of financial crisis from its sample average. We give evidence for the redistribution channel, where inflationary shocks directly cut real incomes, as a possible mechanism. In conjunction with recent literature on the dangers of rapidly tightening monetary policy, our results point to a difficult trade-off for central banks once inflation has risen. JEL Classification: E31, E44, E58, G01

Keywords: currency pegs; financial crises; inflation; monetary policy; oil supply (search for similar items in EconPapers)
Date: 2025-09
New Economics Papers: this item is included in nep-cba, nep-ifn and nep-mon
Note: 451871
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Persistent link: https://EconPapers.repec.org/RePEc:ecb:ecbwps:20253108

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