Staff Memo: Effects of monetary policy in small open economies
News, Staff memo Inflation targeting has now been conducted in many small open economies, such as Sweden’s, for around three decades. A new staff memo analyses the impact of monetary policy on GDP, unemployment, inflation and exchange rates in ten countries with floating exchange rates. A common framework makes the results comparable across countries. The results are in line with previous empirical research and provide no support for the view that the effects in small open economies clearly differ from those estimated for larger economies.
For Sweden, the pass-through of monetary policy to inflation is relatively strong, mainly due to strong relationships between the real economy, the exchange rate and prices. The exchange rate channel appears to be central: an appreciation of the krona following an interest rate increase contributes clearly to lower inflation.
For central banks in small open economies, it is important to assess not only the impact of interest rates on inflation, but also the channels through which this impact occurs. The study analyses these relationships and shows how they differ across countries. The results thereby provide an international benchmark that can contribute to a better understanding of the Swedish transmission mechanism.
Read more in the Staff Memo “Effects of monetary policy in small open economies during the inflation targeting period” by Mika Lindgren, Ingvar Strid and Peiyu Wang, who work in the Riksbank's Monetary Policy Department.