Did Easy Money in the Dollar Bloc Fuel the Oil Price Run-Up?
Among the various explanations for the run-up in oil prices that occurred through mid-2008, one story focuses on the role of monetary policy in the United States and in developing economies. In this view, developing countries that peg their currencies to the dollar were forced to ease their monetary policies in response to reductions in U.S. interest rates, leading to economic overheating and higher oil prices. We assess that hypothesis using simulations of SIGMA, a multi-country DSGE model. Even when the currencies of many developing countries are pegged to the dollar rigidly, an easing of U.S. monetary policy leads to only a transitory run-up in oil prices. Instead, strong economic growth in many developing economies, as well as shortfalls in oil production, better explain the sustained run-up in oil prices observed between 2004 and 2008.
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