The impact of inflation on financial sector performance

John H. Boyd, Ross Levine, Bruce D. Smith

Research output: Contribution to journalArticle

361 Scopus citations

Abstract

A growing theoretical literature describes mechanisms whereby even predictable increases in the rate of inflation interfere with the ability of the financial sector to allocate resources effectively. This paper empirically assesses these predictions. The evidence indicates that there is a significant, and economically important, negative relationship between inflation and both banking sector development and equity market activity. Further, the relationship is nonlinear. As inflation rises, the marginal impact of inflation on banking lending activity and stock market development diminishes rapidly. Moreover, we find evidence of thresholds. For economies with inflation rates exceeding 15 percent, there is a discrete drop in financial sector performance. Finally, while the data indicate that more inflation is not matched by greater nominal equity returns in low-inflation countries, nominal stock returns move essentially one-for-one with marginal increases in inflation in high-inflation economies.

Original languageEnglish (US)
Pages (from-to)221-248
Number of pages28
JournalJournal of Monetary Economics
Volume47
Issue number2
DOIs
StatePublished - Apr 1 2001

Keywords

  • Banks
  • E31
  • Financial Markets
  • G1
  • G2
  • Inflation

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