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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(02), pages 240-277, April.
  • Handle: RePEc:cup:macdyn:v:16:y:2012:i:02:p:240-277_00
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    Cited by:

    1. repec:eee:eneeco:v:66:y:2017:i:c:p:571-581 is not listed on IDEAS
    2. Martin Geiger & Johann Scharler, 2018. "How do consumers interpret the macroeconomic effects of oil price fluctuations? Evidence from U.S. survey data," Working Papers 2018-13, Faculty of Economics and Statistics, University of Innsbruck.
    3. Kang, Wensheng & Ratti, Ronald A. & Vespignani, Joaquin L., 2017. "Oil price shocks and policy uncertainty: New evidence on the effects of US and non-US oil production," Energy Economics, Elsevier, vol. 66(C), pages 536-546.
    4. Benigno, Pierpaolo & Woodford, Michael, 2012. "Linear-quadratic approximation of optimal policy problems," Journal of Economic Theory, Elsevier, vol. 147(1), pages 1-42.
    5. Arnoud Stevens, 2015. "Optimal monetary policy response to endogenous oil price fluctuations," Working Paper Research 277, National Bank of Belgium.
    6. Antonakakis, Nikolaos & Chatziantoniou, Ioannis & Filis, George, 2014. "Dynamic spillovers of oil price shocks and economic policy uncertainty," Energy Economics, Elsevier, vol. 44(C), pages 433-447.
    7. Kang, Wensheng & Ratti, Ronald A., 2013. "Structural oil price shocks and policy uncertainty," Economic Modelling, Elsevier, vol. 35(C), pages 314-319.
    8. Marc Pourroy & Benjamin Carton & Dramane Coulibaly, 2016. "Food Prices and Inflation Targeting in Emerging Economies," International Economics, CEPII research center, issue 146, pages 108-140.
    9. Paul Castillo & Carlos Montoro & Vicente Tuesta, 2005. "Inflation Premium and Oil Price Volatility," Working Papers Central Bank of Chile 350, Central Bank of Chile.
    10. Castillo, Paul & Montoro, Carlos & Tuesta, Vicente., 2010. "Inflation, Oil Price Volatility and Monetary Policy," Working Papers 2010-002, Banco Central de Reserva del Perú.
    11. Jean‐Marc Natal, 2012. "Monetary Policy Response to Oil Price Shocks," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 44(1), pages 53-101, February.
    12. Snudden, Stephen, 2016. "Cyclical fiscal rules for oil-exporting countries," Economic Modelling, Elsevier, vol. 59(C), pages 473-483.
    13. repec:eee:ecmode:v:72:y:2018:i:c:p:42-53 is not listed on IDEAS
    14. Martin Bodenstein & Luca Guerrieri & Lutz Kilian, 2012. "Monetary Policy Responses to Oil Price Fluctuations," IMF Economic Review, Palgrave Macmillan;International Monetary Fund, vol. 60(4), pages 470-504, December.
    15. Degiannakis, Stavros & Filis, George & Panagiotakopoulou, Sofia, 2018. "Oil price shocks and uncertainty: How stable is their relationship over time?," Economic Modelling, Elsevier, vol. 72(C), pages 42-53.
    16. Nikolaos Antonakakis & Ioannis Chatziantoniou & George Filis, 2014. "Dynamic Spillovers of Oil Price Shocks and Policy Uncertainty," Department of Economics Working Papers wuwp166, Vienna University of Economics and Business, Department of Economics.
    17. Kang, Wensheng & Ratti, Ronald A., 2013. "Oil shocks, policy uncertainty and stock market return," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 26(C), pages 305-318.
    18. Andrew Filardo & Jacopo Lombardi & Carlos Montoro, 2018. "Monetary policy spillovers, global commodity prices and cooperation," BIS Working Papers 696, Bank for International Settlements.
    19. Ghassen El Montasser & Kenza Aggad & Louise Clark & Rangan Gupta & Shannon Kemp, 2014. "Causal Link between Oil Price and Uncertainty in India," Working Papers 201467, University of Pretoria, Department of Economics.
    20. repec:eee:phsmap:v:498:y:2018:i:c:p:123-136 is not listed on IDEAS
    21. Liu, Jing-Yu & Lin, Shih-Mo & Xia, Yan & Fan, Ying & Wu, Jie, 2015. "A financial CGE model analysis: Oil price shocks and monetary policy responses in China," Economic Modelling, Elsevier, vol. 51(C), pages 534-543.
    22. Yunqing Wang & Qigui Zhu, 2015. "Energy price shocks, monetary policy and China's economic fluctuations," Asian-Pacific Economic Literature, Asia Pacific School of Economics and Government, The Australian National University, vol. 29(1), pages 126-141, May.
    23. T.V.S.Ramamohan Rao, 2011. "Contemporary Relevance and Ongoing Controversies Related to the CES Production Function," Journal of Quantitative Economics, The Indian Econometric Society, vol. 9(2), pages 36-57, July.
    24. Nicoletta Batini & Eugen Tereanu, 2009. "“What Should Inflation Targeting Countries Do When Oil Prices Rise and Drop Fast?”," IMF Working Papers 09/101, International Monetary Fund.
    25. Rangan Gupta & Hylton Hollander & Mark E. Wohar, 2016. "The Impact of Oil Shocks in a Small Open Economy New-Keynesian Dynamic Stochastic General Equilibrium Model for South Africa," Working Papers 201652, University of Pretoria, Department of Economics.

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    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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