In theory, an exogenous increase in the policy interest rate should lead to a decline in inflation, assuming the demand side effects dominate the supply side effects. However, for emerging market economies many empirical studies based on structural vector autoregressions (SVARs) find that an increase in the policy rate is followed by a rise in prices, a phenomenon known as the price puzzle (e.g., Sims, 1992). One explanation for this puzzle is the misidentification of monetary policy shocks (Ramey (2016). To address this issue, some studies have incorporated proxies for inflation expectations (Sims, 1992; Ha et al., 2025).
An alternative explanation is provided in my paper presented at the ACAES session at the 2026 Allied Social Science Association Annual Meeting. Using high-frequency analysis of monetary policy shocks in Asian economies, the paper shows that positive shocks lead to a depreciation of the exchange rate. The price puzzle arises from this depreciation and the associated exchange rate pass-through to domestic prices. Once this indirect channel is accounted for, the price puzzle disappears, and monetary tightening is seen to achieve the intended lower inflation in the medium term.
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