The Effect of Adverse Oil Price Shocks on Monetary Policy and Output Using a Dynamic Small Open Economy General Equilibrium Model With Staggered Price for Brazil

The aim of the present research is to use a model economy built for Brazil, based on an optimizing dynamic general equilibrium model, in order to perform numerical simulations to derive the ability of the artificial economy to explain the impact of monetary policy interventions on Brazilian short run economic performance in terms of the inflation rate, output gap, interest rate and level of economic activity in the face of an adverse oil shock. It is an extension of Bugarin et al. (2005) concentrating on the consequence of energy price increases, facing different monetary policy rules. Following Hall (1988 e 1990) and Finn (2000) it is considered that an increase in energy prices acts like a negative productivity shock. The model provides an accessible description of an artificial economy with a tractable micro-founded dynamic setting with forward looking rational agents in a small open economy with a staggered pricing mechanism that generates inflation inertia and recessionary disinflations. Alternative specification of monetary reaction functions are introduced into the model economy in order to perform a sensitivity analysis of derived impulse responses to those interventions facing the negative productivity shock. The preliminary results suggest that the introduction of habit persistence into the consumption hypothesis does not make much difference. However the introduction of different monetary reaction functions does alter the impulse response of output, inflation rate, and nominal interest rate. A common result is the decline in potential output for all models. Additionally, the only case where a reduction in the output gap is observed is when using the Taylor rule that takes into consideration the output gap and past interest rates with high persistence.