We develop a tractable model in which a bank’s deposit franchise shapes its risk-taking response to monetary policy. Banks with weaker pass-through to deposit rates (lower deposit betas) see larger profit gains when rates rise and therefore reduce risk-taking more after contractionary shocks. We test this channel using the Federal Reserve’s confidential loan-level data, interacting high-frequency monetary policy surprises with pre-determined banks’ deposit betas, in regressions saturated with bank and borrower-time fixed effects. We find that low-deposit-beta banks reduce risk-taking significantly more following monetary tightening, confirming that the deposit franchise plays a crucial role in the interaction of monetary policy and financial stability. In a horse race against bank capital-based explanations of risk-taking (e.g., search-for-yield), our deposit-franchise mechanism retains independent explanatory power.

We propose a model to study the consequences of incorporating financial stability into the central bank’s objectives when banks are strategic and policy surprises compromise their stability. In this setup, central banks underreact to economic shocks, consistent with the Federal Reserve’s behavior during the 2023 banking crisis. Moreover, policymakers’ financial stability concerns distort banks’ portfolio choices, inducing inefficiency. When the central bank has private information about its policy intentions, forward guidance entails an information loss, highlighting a trade-off between stabilizing markets through policy and communication. A central banker less concerned with financial stability reduces these inefficiencies. Finally, with repeated interactions, the central bank might leverage communication to discipline markets fully.

A vast theoretical literature claims that increasing interest rates reduce bank leverage, making banks safer. Validating this empirically is key to understanding monetary policy transmission and its impact on financial stability. I show that raising interest rates increases bank leverage. This rise in leverage is consequential as it is accompanied by a meaningful increase in bank failure rates. I propose and validate the loan-loss mechanism which explains the entire increase in leverage: contractionary shocks increase loan losses, reduce profits and equity, thus raising leverage. I document why existing models cannot account for this and develop a model of bank risk transformation in which floating-rate loans convert interest rate risk to credit risk, leading to loan losses. Empirical evidence from microdata is consistent with the model’s predictions.

Prizes: IFABS Oxford Best Paper Award, Young Economist Prize (Runner-Up), Southern Economic Association Graduate Student Prize, Rady School of Management Libby Award, Walter Heller Memorial Prize (Best 3rd Year Paper)

Recent and Upcoming Presentations: Bank of England, European Banking Authority, SED Annual Meeting, Annual IJCB Research Conference, FIRS, IFABS Oxford, BIS-CEPR-Gerzensee-SFI Conference on Financial Intermediation, London Juniors Finance Workshop, Bank of Finland and CEPR Joint Conference on Monetary Policy

This paper analyzes food inflation trends in Sub-Saharan Africa (SSA) from 2000 to 2016 using two novel datasets of disaggregated CPI baskets. Average food inflation is higher, more volatile, and similarly persistent as non-food non-fuel inflation, especially in low-income countries in SSA. We find evidence that food inflation became less persistent from 2009 onwards, related to recent improvements in monetary policy frameworks. We also find that high food prices are driven mainly by non-tradable food in SSA and there is incomplete pass-through from world food and fuel prices and exchange rates to domestic food prices. Taken together, these finding suggest that central banks in low-income countries with high and persistent food inflation should continue to pay attention to headline inflation to anchor inflation expectations. Other policy levers include reducing tariffs and improving storage and transport infrastructure to reduce food pressures.