Scandinavian Working Papers in Economics

Working Paper Series,
Sveriges Riksbank (Central Bank of Sweden)

No 387: Drivers of consumer prices and exchange rates in small open economies

Vesna Corbo () and Paola Di Casola ()
Additional contact information
Vesna Corbo: Monetary Policy Department, Central Bank of Sweden, Postal: Sveriges Riksbank, SE-103 37 Stockholm, Sweden
Paola Di Casola: Monetary Policy Department, Central Bank of Sweden, Postal: Sveriges Riksbank, SE-103 37 Stockholm, Sweden

Abstract: We study the fluctuations of exchange rates and consumer prices in two small open economies, Sweden and Canada, using a structural Bayesian VAR. Four domestic and two global shocks are identified through zero and sign restrictions. For both economies, we find that the main driver of consumer price inflation is the global demand shock. A negative global demand shock is not only deflationary for the small open economy, but also depreciates its currency. Hence, the observed exchange rate pass-through following this shock is of opposite sign to what is usually expected. Finally, exogenous shocks to the Exchange rate are less important drivers of exchange rate movements than in many other structural models.

Keywords: Exchange rate pass-through; consumer prices; import prices; monetary policy; global shocks; SVAR

JEL-codes: E31; E52; F31; F41

71 pages, March 1, 2020

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