Inflation-output gap trade-off with a dominant oil supplier

Anton Nakov and Andrea Pescatori ()

No 723, Working Papers from Banco de España

Abstract: An exogenous oil price shock raises inflation and contracts output, similar to a negative productivity shock. In the standard New Keynesian model, however, this does not generate a tradeoff between inflation and output gap volatility: under a strict inflation targeting policy, the output decline is exactly equal to the efficient output contraction in response to the shock. We propose an extension of the standard model in wich the presence of a dominant oil supplier (OPEC) leads to inefficient fluctuations in the oil price markup, reflecting a dynamic distortion of the economy´s production process. As a result, in the face of oil sector shocks, stabilizing inflation does not automatically stabilize the distance of output from first-best, and monetary policymarkers face a tradeoff between the two goals.

Keywords: oil shocks; inflation-output gap tradeoff; dominant firm (search for similar items in EconPapers)
JEL-codes: E31 E32 E52 Q43 (search for similar items in EconPapers)
Pages: 57 pages
Date: 2007-07
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 (10)

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Working Paper: Inflation-output gap trade-off with a dominant oil supplier (2007)
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Persistent link: https://EconPapers.repec.org/RePEc:bde:wpaper:0723

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