Monetary Policy, Inflation, and Crises: 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. Rate hikes (raw or instrumented) increase crisis risk, but only if preceded by prolonged cuts. These patterns are unique to banking crises, unlike noncrisis recessions. Regarding the mechanism, prolonged cuts raise the likelihood of large credit and asset price booms, consistent with higher credit supply and risk-taking. Subsequent hikes strongly reduce credit and asset prices, and increase banks' realized credit risk, rather than interest rate risk. We find consistent results in administrative loan-level data for Spain.