Oil Shocks and Optimal Monetary Policy

Carlos Montoro

No 2007-010, Working Papers from Banco Central de Reserva del Perú

Abstract: This paper investigates how monetary policy should react to oil shocks in a microfounded model with staggered price-setting and oil as a non-produced input in the production function. We extend Benigno and Woodford (2005) to obtain a second order approximation to the expected utility of the representative household when the steady state is distorted and the economy is hit by oil price shocks. The main result is that oil price shocks generate a trade-off between inflation and output stabilisation when oil has low substitutability in production. Therefore, it becomes optimal to the monetary authority to stabilise partially the effects of oil shocks on inflation and some inflation is desirable. We also find, in contrast to Benigno and Woodford (2005), that this trade-off remains even when we eliminate the effects of monopolistic distortions from the steady state. Our results also shed light on how technological improvements which reduces the dependence on oil, also reduce the impact of oil shocks on the economy. This can explain why oil shocks have lower impact on inflation in the 2000s in contrast to the 1970s. Since oil has become easier to substitute with other renewable resources, the impact of oil shocks has been dampened.

Keywords: Optimal Monetary Policy; Welfare; Second Order Solution; Oil Price Shocks; Endogenous Trade-off. (search for similar items in EconPapers)
JEL-codes: D61 E61 (search for similar items in EconPapers)
Date: 2007-08
New Economics Papers: this item is included in nep-cba, nep-ene, nep-mac and nep-mon
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (13)

Downloads: (external link)
https://www.bcrp.gob.pe/docs/Publicaciones/Documen ... ng-Paper-10-2007.pdf Application/pdf
Our link check indicates that this URL is bad, the error code is: 555 Security Page

Related works:
Journal Article: OIL SHOCKS AND OPTIMAL MONETARY POLICY (2012)
Working Paper: Oil shocks and optimal monetary policy (2010)
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:rbp:wpaper:2007-010

Access Statistics for this paper

More papers in Working Papers from Banco Central de Reserva del Perú Contact information at EDIRC.
Bibliographic data for series maintained by Research Unit ().