How does the Weakened Swedish Krona Impact the Inflation? A Bayesian VAR Analysis of Exchange Rate Pass-Through

Abstract: Exchange rate pass-through to prices differ depending on the underlying shock. Furthermore, the mechanisms causing inflation behave diversely, conditional on why the exchange rate fluctuates. This paper investigates how prices react relative to the exchange rate movements, i.e., the exchange rate pass-through, following specific shocks, how the frequency of price adjustment is affected by shocks, and, consecutively, how the frequency affects the price level. The study uses a Bayesian vector autoregression approach with Swedish data from 1995 to 2022. Zero and sign restrictions are imposed, and six shocks are identified, of which two are global. The paper finds that the pass-through to consumer prices is the most significant succeeding monetary policy and exchange rate shocks. Post the Covid-19 pandemic, there has been a shift in the decomposition of consumer price inflation, with global shocks driving a larger share of the variation. Variations in the frequency of price adjustment are primarily driven by global shocks. Moreover, the frequency of price adjustment's pass-through to consumer prices is volatile.