Oil Prices, Monetary Policy, and the Macroeconomy

15 Pages Posted: 28 Oct 2007

See all articles by Charles T. Carlstrom

Charles T. Carlstrom

Federal Reserve Bank of Cleveland

Timothy S. Fuerst

University of Notre Dame

Date Written: April 2005

Abstract

Every U.S. recession since 1971 has been preceded by two things: an oil price shock and an increase in the federal funds rate. Bernanke, Gertler, and Watson (1997, 2004) investigated how much oil price shocks have contributed to output growth by asking the following counterfactual question: Empirically how much would we expect oil price increases to have contributed to output growth if the Fed had kept the rate constant instead of letting it increase? They concluded that, at most, half of the observed output declines can be attributed to oil price increases. Most were actually caused by funds rate increases. A problem with their empirical analysis, however, is that it implicitly assumes that the Fed can continually "fool" the public. That is, the funds rate is led constant even though the public actually expects the Fed to follow its historical policy rule of raising the funds rate in conjunction with oil price increases. We show that if the new policy rule were anticipated oil price increases would have had a much larger impact on output than suggested by Bernanke, Gertler, and Watson's analysis.

Suggested Citation

Carlstrom, Charles T. and Fuerst, Timothy S., Oil Prices, Monetary Policy, and the Macroeconomy (April 2005). FRB of Cleveland Policy Discussion Paper No. 10, Available at SSRN: https://ssrn.com/abstract=1024841 or http://dx.doi.org/10.2139/ssrn.1024841

Charles T. Carlstrom (Contact Author)

Federal Reserve Bank of Cleveland ( email )

PO Box 6387
Cleveland, OH 44101-1387
United States
216-579-2294 (Phone)
216-579-3050 (Fax)

Timothy S. Fuerst

University of Notre Dame ( email )

Notre Dame, IN 46556
United States

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