Prices and Monetary Policy: The Role of Financial Constraints

Michael Bauer, Alexander Czarnota and Mathias Klein

No 21748, CEPR Discussion Papers from Centre for Economic Policy Research

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 explain our main heterogeneity result.

Keywords: Monetary; transmission (search for similar items in EconPapers)
JEL-codes: E31 (search for similar items in EconPapers)
Date: 2026-07
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