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Oil Shocks And Optimal Monetary Policy

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  • Montoro, Carlos

Abstract

This paper studies how monetary policy should react to oil shocks in a microfounded model with staggered price-setting and oil as an input in a CES production function. In particular, we extend Benigno and Woodford [Journal of the European Economic Association 3 (6) (2005), 1–52] to obtain a second-order approximation to the expected utility of the representative household when the steady state is distorted and the economy is hit by oil price shocks. The main result is that oil price shocks generate an endogenous trade-off between inflation and output stabilization when oil has low substitutability in production. We also find, in contrast to Benigno and Woodford, that this trade-off is reduced, but not eliminated, when we get rid of the effects of monopolistic distortions in the steady state. Moreover, the size of the endogenous “cost-push” shock generated by fluctuations in the oil price increases when it is more difficult to substitute other factors for oil.

Suggested Citation

  • Montoro, Carlos, 2012. "Oil Shocks And Optimal Monetary Policy," Macroeconomic Dynamics, Cambridge University Press, vol. 16(2), pages 240-277, April.
  • Handle: RePEc:cup:macdyn:v:16:y:2012:i:02:p:240-277_00
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    References listed on IDEAS

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    More about this item

    JEL classification:

    • D61 - Microeconomics - - Welfare Economics - - - Allocative Efficiency; Cost-Benefit Analysis
    • E61 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Policy Objectives; Policy Designs and Consistency; Policy Coordination

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