Oil Price Shocks, Monetary Policy and Stagflation

One of the central questions in recent macroeconomic history is to what extent monetary policy as opposed to oil price shocks contributed to the stagflation of the 1970s. Understanding what went wrong in the 1970s is the key to learning from the past. One explanation explored in Barsky and Kilian (2002) is that worldwide shifts in monetary policy regimes not related to the oil market played a major role in causing both the major oil price increases of the 1970s and stagflation in many economies. A competing view exemplified by Bernanke, Gertler and Watson (1997) is that the oil price shocks of the 1970s and 1980s arose exogenously with respect to global macroeconomic conditions, but were propagated by the reaction of monetary policy makers, causing stagflation in the process. This paper reviews the evidence for these two main explanations, interprets recent events in light of this evidence, and outlines implications for monetary policy.