Insights into the sovereign-bank nexus: Can inflation and money supply affect the doom loop?

This study extends the literature on the sovereign-bank connection through the lens of inflation and money supply. Using quarterly data since 1966 about the debt-to-GDP ratio, bank lending, inflation and M3 and employing the innovative Quantile-VAR framework and different market conditions, insights are provided on the relation between the sovereign debt burden and bank lending capacity and how this is influenced by expansionary monetary policy and inflationary pressures that strengthen debt accumulation. Findings reveal that the high debt ratio along with lax monetary action taking is the primary source of spillovers on bank lending and the continuation of this vicious circle whereas inflation acts as a financial stabilizer vis-à-vis the doom loop that increases the resilience of the system to shocks of excess debt ratio or liquidity injections. Notably, the debt ratio feeds inflation. These findings underline that policymakers should focus on restraining public debt and slow down on expansionary central bank practices for enhancing bank stability and reducing inflation.