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Prices and Monetary Policy: The Role of Financial Constraints

Author

Listed:
  • Bauer, Michael

    (Federal Reserve Bank of San Francisco and CEPR)

  • Czarnota, Alexander

    (Monetary Policy Department, Central Bank of Sweden)

  • Klein, Mathias

    (Research Department, Central Bank of Sweden)

Abstract

Firm heterogeneity in financial constraints is a quantitatively important driver of how monetary policy transmits to inflation. Using detailed microdata on Swedish public and private firms, and high-frequency monetary policy surprises around Riksbank announcements, we document that smaller, financially constrained firms adjust prices significantly less than larger firms in response to changes in monetary policy. This heterogeneous price response materially dampens the aggregate PPI inflation response to monetary policy. Models of customer markets and financial frictions can explain our findings: because the external finance premium rises after a monetary contraction, constrained firms cut prices less to preserve cash flows, sacrificing future market share. Additional evidence on heterogeneous sales, debt, marginal cost, and markup responses further supports this channel. We consider several alternative explanations, including differences in price adjustments, working capital, market share, and export share, but these cannot rationalize our main heterogeneity result.

Suggested Citation

  • Bauer, Michael & Czarnota, Alexander & Klein, Mathias, 2026. "Prices and Monetary Policy: The Role of Financial Constraints," Working Paper Series 468, Sveriges Riksbank (Central Bank of Sweden).
    • Handle: RePEc:hhs:rbnkwp:0468
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    More about this item

    Keywords

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    JEL classification:

    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • L11 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Production, Pricing, and Market Structure; Size Distribution of Firms

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