This paper examines the intricate relationship between monetary policy, interest rates, and financial stability in the context of high inflation. This research examines the interaction of interest rate adjustments, inflationary pressures, exchange rate volatility, and macroprudential measures on banking sector resilience, utilizing a panel dataset of 20 nations (10 advanced and 10 emerging) from 2010 to 2022. Utilizing a System GMM framework, financial stability is represented by non-performing loans, bank Z-scores, and liquidity coverage ratios. Findings indicate that whereas interest rate increases alleviate inflation, they concurrently elevate systemic financial risks by augmenting loan defaults, diminishing liquidity, and undermining bank stability, especially in emerging markets. In contrast, macroprudential regulations substantially enhance financial resilience, alleviating the detrimental impacts of inflation and interest rate fluctuations. The results underscore the intrinsic policy trade-off between price stability and financial stability, indicating that a cohesive policy approach—harmonizing interest rate management with specific macroprudential instruments—provides a more durable framework. These insights provide practical recommendations for central banks to address inflationary pressures while maintaining the integrity of the banking sector.
Munir et al. (Thu,) studied this question.