Cleveland Fed: Banking sector distress has little-to-no impact on inflation

Distress in the banking sector typically reduces the credit supply and GDP growth, but it doesn’t have an impact on inflation, according to a new report from the Center for Inflation Research at the Federal Reserve Bank of Cleveland.

There are virtually no differences in the path of the Consumer Price Index in the years before and after large declines in bank equity prices in advanced economies, despite the significant impact those large declines have on the credit supply and GDP.

“These findings suggest that the collapse of several regional banks in early 2023 would not, on its own, put downward pressure on inflation,” writes research economist Ina Hajdini.

Why not? Previous research shows that, in the wake of banking stress, some firms raise prices to preserve liquidity, mitigating downward pressure on inflation from reduced economic activity.

Phillips curve logic would suggest that reduced economic activity would reduce inflation, “but this line of thinking may not be consistent with the evidence,” Hajdini writes.

Read the Economic Commentary: Implications of Bank Equity Price Declines for Inflation

More on inflation: The Center for Inflation Research