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Monetary Tightening and Financial Stress during Supply- versus Demand-Driven Inflation

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Abstract

The paper explores the state-dependent effects of a monetary policy tightening on financial stress, focusing on a novel dimension: whether inflation is driven by supply factors versus demand factors at the time of the policy intervention. We use local projections to estimate the effect of high frequency identified monetary policy surprises on a variety of financial stress measures, differentiating the effects based on whether inflation is supply-driven or demand-driven. We find that financial stress flares up after a monetary tightening when inflation is supply-driven whereas it remains roughly unchanged or even declines when inflation is demand-driven. Our findings point to a potential trade-off between price and financial stability when inflation is high and driven by supply factors.

Suggested Citation

  • Frederic Boissay & Fabrice Collard & Cristina Manea & Adam Hale Shapiro, 2024. "Monetary Tightening and Financial Stress during Supply- versus Demand-Driven Inflation," Working Paper Series 2023-38, Federal Reserve Bank of San Francisco.
    • Handle: RePEc:fip:fedfwp:97503
    DOI: 10.24148/wp2023-38
    Note: Original title: Monetary Tightening, Inflation Drivers and Financial Stress. Original publication date: 2023/12/15
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    JEL classification:

    • E1 - Macroeconomics and Monetary Economics - - General Aggregative Models
    • E3 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles
    • E6 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook
    • G01 - Financial Economics - - General - - - Financial Crises

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