Oil Shocks and Aggregate Macroeconomic Behavior: The Role of Monetary Policy

Ana María Herrera and James Hamilton

University of California at San Diego, Economics Working Paper Series from Department of Economics, UC San Diego

Abstract: A recent paper by Bernanke, Gertler and Watson (1997) suggests that monetary policy could be used to eliminate any recessionary consequences of an oil price shock. This paper challenges that conclusion on two grounds. First, we question whether the Federal Reserve actually has the power to implement such a policy; for example, we consider it unlikely that additional money creation would have succeeded in reducing the Fed funds rate by 900 basis points relative to the values seen in 1974. Second, we point out that the size of the effect that Bernanke, Gertler and Watson attribute to oil shocks is substantially smaller than that reported by other researchers, primarily due to their choice of a shorter lag length than used by other researchers. We offer evidence in favor of the longer lag length employed by previous research, and show that, under this specification, even the aggressive Federal Reserve policies proposed would not have succeeded in averting a downturn.

Keywords: regime switch; oil shocks (search for similar items in EconPapers)
Date: 2001-07-01
References: View complete reference list from CitEc
Citations: View citations in EconPapers (54)

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