Monetary policy effects in small economies: Stable, but inflation sensitive
A Riksbank staff memo estimates the effects of monetary policy in ten small open economies using a standardised SVAR framework. The study finds policy effects are broadly stable over time but inflation responses are sensitive to measurement.
Small economies, big policy impact
The study employs a standardised structural VAR framework to estimate the effects of monetary policy in ten small open economies (SOEs) with inflation targeting and flexible exchange rates: Australia, Canada, Chile, the Czech Republic, Iceland, New Zealand, Norway, Poland, Sweden, and the United Kingdom.
This comparative analysis provides directly comparable estimates of policy effects on inflation, GDP, unemployment, and the exchange rate.
In the cross-country aggregate, the estimated effects of a policy-rate increase for the group of SOEs align with macroeconomic theory and are consistent with broader VAR evidence.
The magnitudes are also similar to those typically reported for larger economies like the United States and the euro area.
Elasticities shape diverse outcomes
Cross-country differences in monetary policy effects are better explained by transmission elasticities—such as the Okun coefficient, Phillips slope, and exchange rate pass-through—rather than co-movement among raw variable responses.
For instance, larger inflation responses correlate more with a steeper Phillips slope than with a larger GDP response.
The study also concludes that the estimated effects of monetary policy on inflation and GDP across the ten SOEs appear broadly stable over time.
Even where point estimates suggest a modest increase, these changes are generally not statistically significant, implying overall stability during the inflation targeting period.
Inflation's stubborn puzzle
The study's finding of a 'price puzzle' in half the countries critically highlights a significant methodological challenge in monetary policy analysis.
While core inflation and sign restrictions offer solutions, the persistent sensitivity of inflation responses underscores the difficulty of robustly measuring policy impact.
This suggests standard models may still struggle to fully capture complex transmission channels in small open economies.