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Macro-banking stability, sovereign debt and the inflation channel

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  • Cao, Qingqing
  • Minetti, Raoul
  • Rowe, Nicholas

Abstract

We investigate the impact of inflation on banking stability. Using granular U.S. data from 1997 to 2014, we show that higher inflation induces a significant deterioration of banks’ capital position because of the maturity mismatch of banks’ assets and liabilities. Quantitative analysis reveals that the elasticity of banking capital to long-term inflation expectations is high, as a 1% increase to long-term inflation expectations leads to a 15% decrease in banks’ Tier 1 capital. The analysis suggests that the use of inflation to reduce sovereigns’ real debt burden could aggravate the sovereign-bank loop during debt crises.

Suggested Citation

  • Cao, Qingqing & Minetti, Raoul & Rowe, Nicholas, 2025. "Macro-banking stability, sovereign debt and the inflation channel," Finance Research Letters, Elsevier, vol. 78(C).
    • Handle: RePEc:eee:finlet:v:78:y:2025:i:c:s1544612325004076
    DOI: 10.1016/j.frl.2025.107144
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    References listed on IDEAS

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    Keywords

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    JEL classification:

    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • H63 - Public Economics - - National Budget, Deficit, and Debt - - - Debt; Debt Management; Sovereign Debt
    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation

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