Optimal monetary responses to oil discoveries

Samuel Wills

LSE Research Online Documents on Economics from London School of Economics and Political Science, LSE Library

Abstract: This paper studies how monetary policy should respond to news about an oil discovery, using a workhorse New Keynesian model. Good news about future production can create a recession today under exchange rate pegs and a simple Taylor rule, as seen in practice. This is explained by forward-looking inflation. Recession is avoided by a Taylor rule that accommodates changes in the natural level of output, which closely approximates optimal policy. Central banks have an incentive to exploit oil revenues by appreciating the terms of trade, creating “Dutch disease” and a deflationary bias which is overcome by committing to future policy.

Keywords: natural resources; oil; optimal monetary policy; small open economy; news shock (search for similar items in EconPapers)
JEL-codes: E52 E62 F41 O13 Q30 Q33 (search for similar items in EconPapers)
Pages: 59 pages
Date: 2014-04
New Economics Papers: this item is included in nep-cba, nep-ene, nep-mac, nep-mon and nep-opm
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Citations: View citations in EconPapers (4)

Downloads: (external link)
http://eprints.lse.ac.uk/58104/ Open access version. (application/pdf)

Related works:
Working Paper: Optimal Monetary Responses to Oil Discoveries (2014)
Working Paper: Optimal Monetary Responses to Oil Discoveries (2014)
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Persistent link: https://EconPapers.repec.org/RePEc:ehl:lserod:58104

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