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Monetary Policy Responses to Oil Price Fluctuations

Author

Listed:
  • Martin Bodenstein
  • Luca Guerrieri
  • Lutz Kilian

Abstract

The paper provides the first quantitative analysis of how U.S. monetary policy responses should differ depending on the source of the observed oil price fluctuations. It presents three main sets of results. First, the paper proposes a novel decomposition of the marginal cost of production that highlights the role of each factor input for the evolution of inflation. Second, conditional on an estimated interest rate policy reaction function, the paper demonstrates that no two structural shocks induce the same monetary policy response, even after controlling for the impact response of the real price of oil, and quantifies these differences. Third, the paper shows that the policy responses implied by a policy rule, whose coefficients were chosen to maximize U.S. welfare, differ substantially from the policy response implied by the same rule estimated on historical data. Among a wide range of rules, a rule that is easily implementable and that nearly maximizes U.S. welfare involves the Federal Reserve putting zero weight on the price of oil and responding to wage inflation without interest rate smoothing.

Suggested Citation

  • 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.
  • Handle: RePEc:pal:imfecr:v:60:y:2012:i:4:p:470-504
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    More about this item

    JEL classification:

    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • F32 - International Economics - - International Finance - - - Current Account Adjustment; Short-term Capital Movements
    • Q43 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Energy - - - Energy and the Macroeconomy

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