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Inflation-output gap trade-off with a dominant oil supplier

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Author Info
Anton Nakov () (Banco de España)
Andrea Pescatori () (Universitat Pompeu Fabra)

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Abstract

An exogenous oil price shock raises inflation and contracts output, similar to a negative productivity shock. In the standard New Keynesian model, however, this does not generate a tradeoff between inflation and output gap volatility: under a strict inflation targeting policy, the output decline is exactly equal to the efficient output contraction in response to the shock. We propose an extension of the standard model in wich the presence of a dominant oil supplier (OPEC) leads to inefficient fluctuations in the oil price markup, reflecting a dynamic distortion of the economy´s production process. As a result, in the face of oil sector shocks, stabilizing inflation does not automatically stabilize the distance of output from first-best, and monetary policymarkers face a tradeoff between the two goals.

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File URL: http://www.bde.es/informes/be/docs/dt0723e.pdf
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File Function: First version, July 2007
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Paper provided by Banco de España in its series Banco de España Working Papers with number 0723.

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Length: 57 pages
Date of creation: Jul 2007
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Handle: RePEc:bde:wpaper:0723

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Keywords: oil shocks inflation-output gap tradeoff dominant firm

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Find related papers by 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
Q43 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Energy - - - Energy and the Macroeconomy

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References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
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Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Antón Nákov & Andrea Pescatori, 2007. "Oil and the Great Moderation," Banco de España Working Papers 0735, Banco de España. [Downloadable!]
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