Does the Fed Respond to Oil Price Shocks?

Lutz Kilian and Logan Lewis

No 7594, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: 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.

Keywords: Counterfactual; Oil; Recessions; Systematic monetary policy; Temporal instability (search for similar items in EconPapers)
JEL-codes: E31 E32 E52 Q43 (search for similar items in EconPapers)
Date: 2009-12
New Economics Papers: this item is included in nep-cba, nep-ene, nep-mac and nep-mon
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Citations: View citations in EconPapers (11)

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Journal Article: Does the Fed Respond to Oil Price Shocks? (2011)
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