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

Abstract

This paper explores the state-dependent effects of a monetary tightening on financial stress, focusing on a novel dimension: whether inflation is driven by supply versus demand factors at the time of the policy intervention. These underlying factors likely affect the economy’s financial resilience to a monetary tightening. We estimate the effects of high-frequency identified monetary surprises on financial stress, differentiating the effects based on whether inflation is supply-or demanddriven. We find that financial stress increases after a tightening when inflation is supply-driven, whereas it remains roughly unchanged or even declines when inflation is demand-driven.