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Does the Fed Respond to Oil Price Shocks?

  • Kilian, Lutz
  • Lewis, Logan

Since Bernanke, Gertler and Watson (1997), a common view in the literature has been that systematic monetary policy responses to the inflation triggered by oil price shocks are an important source of aggregate fluctuations in the U.S. economy. We show that there is no evidence of systematic monetary policy responses to oil price shocks after 1987 and that this lack of a policy response is unlikely to be explained by reduced real wage rigidities. Prior to 1987, according to standard VAR models, the Federal Reserve was not responding to the inflation triggered by oil price shocks, as commonly presumed, but rather to the oil price shocks directly, consistent with a preemptive move by the Federal Reserve to counteract potential inflationary pressures. There are indications that this response is poorly identified, however, and there is no evidence that this policy response in the pre-1987 period caused substantial fluctuations in the Federal Funds rate or in real output. Our analysis suggests that the traditional monetary policy reaction framework explored by BGW and incorporated in subsequent DSGE models should be replaced by DSGE models that take account of the endogeneity of the real price of oil and that allow policy responses to depend on the underlying causes of oil price shocks.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 7594.

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Date of creation: Dec 2009
Date of revision:
Handle: RePEc:cpr:ceprdp:7594
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  1. Bénédicte Vidaillet & V. D'Estaintot & P. Abécassis, 2005. "Introduction," Post-Print hal-00287137, HAL.
  2. Robert Barsky & Lutz Kilian, 2004. "Oil and the Macroeconomy Since the 1970s," NBER Working Papers 10855, National Bureau of Economic Research, Inc.
  3. Kilian, Lutz & Vega, Clara, 2008. "Do Energy Prices Respond to U.S. Macroeconomic News? A Test of the Hypothesis of Predetermined Energy Prices," CEPR Discussion Papers 7015, C.E.P.R. Discussion Papers.
  4. Kilian, Lutz & Vigfusson, Robert J., 2009. "Pitfalls in Estimating Asymmetric Effects of Energy Price Shocks," CEPR Discussion Papers 7284, C.E.P.R. Discussion Papers.
  5. Lutz Kilian, 2009. "Not All Oil Price Shocks Are Alike: Disentangling Demand and Supply Shocks in the Crude Oil Market," American Economic Review, American Economic Association, vol. 99(3), pages 1053-69, June.
  6. International Monetary Fund, 2007. "Oil Shocks and External Balances," IMF Working Papers 07/110, International Monetary Fund.
  7. Goncalves, Silvia & Kilian, Lutz, 2004. "Bootstrapping autoregressions with conditional heteroskedasticity of unknown form," Journal of Econometrics, Elsevier, vol. 123(1), pages 89-120, November.
  8. Bańbura, Marta & Giannone, Domenico & Reichlin, Lucrezia, 2008. "Large Bayesian VARs," Working Paper Series 0966, European Central Bank.
  9. Robert B. Barsky & Lutz Kilian, 2002. "Do We Really Know that Oil Caused the Great Stagflation? A Monetary Alternative," NBER Chapters, in: NBER Macroeconomics Annual 2001, Volume 16, pages 137-198 National Bureau of Economic Research, Inc.
  10. Kilian, Lutz, 2009. "Oil Price Shocks, Monetary Policy and Stagflation," CEPR Discussion Papers 7324, C.E.P.R. Discussion Papers.
  11. Leduc, Sylvain & Sill, Keith, 2004. "A quantitative analysis of oil-price shocks, systematic monetary policy, and economic downturns," Journal of Monetary Economics, Elsevier, vol. 51(4), pages 781-808, May.
  12. Herrera, Ana María & Pesavento, Elena, 2009. "Oil Price Shocks, Systematic Monetary Policy, And The “Great Moderation”," Macroeconomic Dynamics, Cambridge University Press, vol. 13(01), pages 107-137, February.
  13. Angelini, Elena & Henry, Jérôme & Marcellino, Massimiliano, 2003. "Interpolation and backdating with a large information set," Working Paper Series 0252, European Central Bank.
  14. James D. Hamilton, 2000. "What is an Oil Shock?," NBER Working Papers 7755, National Bureau of Economic Research, Inc.
  15. Luca Guerrieri & Christopher Erceg & Martin Bodenstein, 2008. "Oil Shocks and External Adjustment," 2008 Meeting Papers 945, Society for Economic Dynamics.
  16. Kilian, Lutz, 2007. "The Economic Effects of Energy Price Shocks," CEPR Discussion Papers 6559, C.E.P.R. Discussion Papers.
  17. Edelstein, Paul & Kilian, Lutz, 2009. "How sensitive are consumer expenditures to retail energy prices?," Journal of Monetary Economics, Elsevier, vol. 56(6), pages 766-779, September.
  18. Anton Nakov & Andrea Pescatori, 2007. "Inflation-output gap trade-off with a dominant oil supplier," Working Paper 0710, Federal Reserve Bank of Cleveland.
  19. repec:acb:camaaa:2010-38 is not listed on IDEAS
  20. Kilian, Lutz, 2005. "The Effects of Exogenous Oil Supply Shocks on Output and Inflation: Evidence from the G7 Countries," CEPR Discussion Papers 5404, C.E.P.R. Discussion Papers.
  21. Renee Fry & Callum Jones & Christopher Kent, 2010. "Inflation in an Era of Relative Pirce Shocks," CAMA Working Papers 2010-38, Centre for Applied Macroeconomic Analysis, Crawford School of Public Policy, The Australian National University.
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