Our Blog

Our recent FLAR working paper, “Government Debt Expansion and Bank Capitalization: The Conditioning Role of Institutional Quality,” explores how banks’ capital ratios respond to government debt-to-GDP shocks and how this response varies with regulatory quality. Bank capital is a central element of financial stability, and its cyclical behavior has received considerable attention in the macroprudential literature. While earlier studies show that adjustments in capital buffers depend strongly on institutional strength and regulatory design, a parallel body of research examines the interplay between fiscal conditions and banking stability.

The pandemic was not only a health crisis; it also transformed the macroeconomic landscape of the region. In our new blog, we present the results of our recent research, in which we analyze how expansions in public spending during and after COVID-19 contributed to the increase and persistence of inflation in several Latin American countries.

The study finds that increases in public debt tend to reduce bank capital, but the size and timing of the adjustment depend on institutional quality. In strong regulatory systems the impact is immediate and later reverses, while in weaker environments the adjustment is slower.

The study shows that although bank capital ratios in emerging economies were procyclical before 2014, over the past decade they have become less cyclical or even countercyclical. Banks with larger capital buffers respond better during downturns, and regions such as Latin America, developing Asia, and the Middle East show the greatest improvements, reflecting the growing influence of macroprudential regulation.

The study shows that in Latin America, between 2002 and 2023, increases in government spending—especially during the pandemic—raised inflation, with stronger effects in countries with lower fiscal credibility and shorter-maturity debt. Unlike in OECD economies, this inflationary impact persists outside the COVID-19 period, highlighting structural vulnerabilities in the region.

The post-pandemic resurgence of inflation has renewed attention on inflation persistence and the role of central banks in maintaining credibility. While conventional explanations emphasize fiscal discipline, exchange rate regimes, or inflation targeting, these factors do not fully explain why some countries return rapidly to price stability while others experience prolonged inflationary episodes.

The post-pandemic resurgence of inflation has renewed attention on its persistence and the role of central banks in maintaining credibility. Conventional explanations emphasize fiscal discipline, exchange rate regimes, or inflation targeting. However, these factors do not fully explain why some countries return rapidly to price stability while others experience prolonged inflationary episodes. We argue that central bank transparency—the clarity of communication regarding objectives, policy decisions, and macroeconomic forecasts—is a key determinant of inflation persistence.