Inflation and Disintermediation

In a 47-country panel, large inflation increases are followed by aggregate lending contractions, driven by banks with balance sheets most exposed to inflation. We explore how rising inflation affects the macroeconomy through a banking channel by studying an early-1977 unexpected increase in inflation in the U.S. Our identification strategy exploits differences in reserve requirements across U.S. states for Fed nonmember banks, leading banks to be differentially exposed to unexpected inflation increases. More exposed banks cut lending, reducing local house prices, construction employment, and firm investment. Our results suggest an important consequence of inflation is its impairment of the banking sector