Monetary Policy Responses to Oil Price Fluctuations

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 highl...

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Bibliographic Details
Published in:IMF economic review 2012-12, Vol.60 (4), p.470-504
Main Authors: BODENSTEIN, MARTIN, GUERRIERI, LUCA, KILIAN, LUTZ
Format: Article
Language:English
Subjects:
Analysis
Capital Markets
Cost
Crude oil
Crude oil prices
E31
E43
Economic fluctuations
Economic Policy
Economics
Economics and Finance
F41
Forecasts and trends
Foreign exchange rates
Fuel oil prices
Inflation
Inflation (Finance)
Inflation rates
Interest rates
International Economics
International trade
Macroeconomics/Monetary Economics//Financial Economics
Monetary policy
Oil price shocks
Oil prices
Output gaps
Phillips curve
Price fluctuations
Prices
Production
Q43
Standard deviation
Studies
Supply shocks
United States
Welfare economics
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Summary: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.
ISSN:2041-4161
2041-417X
DOI:10.1057/imfer.2012.19