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Expectations, Learning, and the Changing Relationship between Oil Prices and the Macroeconomy

Fabio Milani ()

No 80923, Working Papers from University of California-Irvine, Department of Economics

Abstract: This paper estimates a structural general equilibrium model to investigate the changing relationship between the oil price and macroeconomic variables. The oil price, through the role of oil in production and consumption, affects aggregate demand and supply in the model. The assumption of rational expectations is relaxed in favor of learning. Oil prices, therefore, affect the economy through an additional channel, i.e. through their effect on the formation of agents' beliefs. The estimated learning dynamics indicates that economic agents' perceptions about the effects of oil prices on the economy have changed over time: oil prices were perceived to have large effects on output and inflation in the 1970s, but only milder effects after the mid-1980s. Since expectations play a large role in the determination of output and inflation, the effects of oil price increases on expectations can magnify the response of macroeconomic variables to oil price shocks. In the estimated model, in fact, the implied responses of output and inflation to oil price shocks were much more pronounced in the 1970s than in 2008. Therefore, through the time variation in the impact of oil prices on beliefs, the paper can successfully explain the observed weakening of the effects of oil price shocks on real activity and inflation.

Keywords: Oil price; Inflation expectations; Learning; Monetary policy, Effect of energy shocks; Bayesian estimation (search for similar items in EconPapers)
JEL-codes: E31 E52 E58 F43 (search for similar items in EconPapers)
Pages: 31 pages
Date: 2009-06
New Economics Papers: this item is included in nep-cba, nep-ene, nep-mac and nep-opm
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (12) Track citations by RSS feed

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