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Optimal Monetary Responses to Oil Discoveries

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  • Samuel Wills

    ()
    (Oxford Centre for the Analysis of Resource Rich Economies (OxCarre), Department of Economics, University of Oxford; Centre for Macroeconomics (CFM); Centre for Applied Macroeconomic Analysis, Australian National University.
    Centre for Macroeconomics (CFM))

Abstract

This paper studies how monetary policy should respond to news about an oil discovery, using a workhorse New Keynesian model. Good news about future production can create a recession today under exchange rate pegs and a simple Taylor rule, as seen in practice. This is explained by forward-looking inflation. Recession is avoided by a Taylor rule that accommodates changes in the natural level of output, which closely approximates optimal policy. Central banks have an incentive to exploit oil revenues by appreciating the terms of trade, creating “Dutch disease” and a deflationary bias which is overcome by committing to future policy.

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File URL: http://www.centreformacroeconomics.ac.uk/pdf/CFMDP2014-08-Paper.pdf
File Function: Revised version, 2014
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Bibliographic Info

Paper provided by Centre for Macroeconomics (CFM) in its series Discussion Papers with number 1408.

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Length: 59 pages
Date of creation: Oct 2012
Date of revision: Apr 2014
Handle: RePEc:cfm:wpaper:1408

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Keywords: Natural resources; oil; optimal monetary policy; small open economy; news shock;

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Cited by:
  1. Frederick van der Ploeg, 2014. "Guidelines for Exploiting Natural Resource Wealth," OxCarre Working Papers, Oxford Centre for the Analysis of Resource Rich Economies, University of Oxford 128, Oxford Centre for the Analysis of Resource Rich Economies, University of Oxford.

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