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Oil Price Dynamics and Monetary Policy in a Heterogeneous Monetary Union

  • Clausen Volker

    ()

    (University of Duisburg-Essen, Department of Economics, 45117 Essen, Germany)

  • Wohltmann Hans-Werner

    ()

    (University of Kiel, Institute of Economics, 24098 Kiel, Germany)

This paper analyzes the dynamic effects of oil price increases in a small two-country monetary union with asymmetric wage adjustment equations. Common oil price shocks lead during the adjustment process to temporary divergences in output and inflation and also to reversals in the relative cyclical position across the monetary union. We distinguish between three types of oil price shocks: (1) an unanticipated permanent shock, (2) an unanticipated temporary shock and (3) an anticipated permanent shock.We illustrate the macroeconomic effects of these shocks by means of dynamic simulations and examine the respective stabilization role of monetary policy. While permanent oil price hikes always lead to stagflation, temporary shocks are associated with deflation in the very short run as the reduction of real income lowers the demand for the domestically produced good. The implications for monetary policy are also shock-specific. Monetary policy faces a signal extraction problem as it needs to determine whether oil price shocks are transitory or permanent in order to make appropriate decisions not only about the strength, but also the direction of monetary policy.

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Article provided by De Gruyter in its journal Journal of Economics and Statistics (Jahrbuecher fuer Nationaloekonomie und Statistik).

Volume (Year): 233 (2013)
Issue (Month): 2 (April)
Pages: 159-187

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Handle: RePEc:jns:jbstat:v:233:y:2013:i:2:p:159-187
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  1. Buiter, Willem H. & Miller, Marcus, 1982. "Real exchange rate overshooting and the output cost of bringing down inflation," European Economic Review, Elsevier, vol. 18(1), pages 85-123.
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