Oil Price Dynamics and Monetary Policy in a Heterogeneous Monetary Union

Volker Clausen and Hans-Werner Wohltmann

Journal of Economics and Statistics (Jahrbuecher fuer Nationaloekonomie und Statistik), 2013, vol. 233, issue 2, 159-187

Abstract: This paper analyzes the dynamic effects of oil price increases in a small two-country monetary union with asymmetric wage adjustment equations. Common oil price shocks lead during the adjustment process to temporary divergences in output and inflation and also to reversals in the relative cyclical position across the monetary union. We distinguish between three types of oil price shocks: (1) an unanticipated permanent shock, (2) an unanticipated temporary shock and (3) an anticipated permanent shock.We illustrate the macroeconomic effects of these shocks by means of dynamic simulations and examine the respective stabilization role of monetary policy. While permanent oil price hikes always lead to stagflation, temporary shocks are associated with deflation in the very short run as the reduction of real income lowers the demand for the domestically produced good. The implications for monetary policy are also shock-specific. Monetary policy faces a signal extraction problem as it needs to determine whether oil price shocks are transitory or permanent in order to make appropriate decisions not only about the strength, but also the direction of monetary policy.

Keywords: EMU; international policy transmission; oil price shock; time inconsistency; monetary policy; signal extraction problem; EMU; international policy transmission; oil price shock; time inconsistency; monetary policy; signal extraction problem (search for similar items in EconPapers)
Date: 2013
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Citations: View citations in EconPapers (1)

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Persistent link: https://EconPapers.repec.org/RePEc:jns:jbstat:v:233:y:2013:i:2:p:159-187

DOI: 10.1515/jbnst-2013-0203

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