Exchange Rates, Oil Price Shocks, and Monetary Policy In an Economy with Traded and Non-Traded Goods
37 Pages Posted: 19 Aug 2009 Last revised: 17 Dec 2015
Date Written: August 14, 2009
Abstract
This paper examines monetary policy responses to oil price shocks in a small open economy that produces traded and non-traded goods. When only labor and oil are used in production and prices are sticky in the non-traded sector the behavior of inflation, the nominal exchange rate, and the relative price of the non-traded good depends crucially upon whether the ratio of the cost share of oil to the cost share of labor is higher for the traded or non-traded sector. If the ratio is smaller (higher) for the traded sector then a policy that fully stabilizes non-traded inflation causes the nominal exchange rate to appreciate (depreciate) and the relative price of the non-traded good to rise (fall) when there is a surprise rise in the price of oil. Similar results can hold for a policy that stabilizes CPI inflation. Under a policy that flexes the nominal exchange rate, non-traded inflation rises (falls) if the ratio is smaller (larger) for the traded sector. Analytical results show that a policy of fixing the exchange rate always produces a unique solution and that a policy of stabilizing non-traded inflation produces a unique solution so long as the nominal interest rate is raised more than one-for-one with rises in non-traded inflation. A policy that stabilizes CPI inflation, however, produces multiple equilibria for a wide range of calibrations of the policy rule.
Keywords: oil prices, monetary policy, inflation, exchange rates
JEL Classification: F41, E52, Q43
Suggested Citation: Suggested Citation
Do you have negative results from your research you’d like to share?
Recommended Papers
-
Imperfect Competition and the Effects of Energy Price Increases on Economic Activity
-
Not All Oil Price Shocks are Alike: Disentangling Demand and Supply Shocks in the Crude Oil Market
By Lutz Kilian
-
Do We Really Know that Oil Caused the Great Stagflation? A Monetary Alternative
By Robert Barsky and Lutz Kilian
-
Oil and the Macroeconomy Since the 1970s
By Robert Barsky and Lutz Kilian
-
Oil and the Macroeconomy Since the 1970s
By Robert Barsky and Lutz Kilian
-
The Macroeconomic Effects of Oil Price Shocks: Why are the 2000s so Different from the 1970s?
By Olivier J. Blanchard and Jordi Galí
-
The Macroeconomic Effects of Oil Shocks: Why are the 2000s so Different from the 1970s?
By Olivier J. Blanchard and Jordi Galí
-
The Macroeconomic Effects of Oil Shocks: Why are the 2000s so Different from the 1970s?
By Olivier J. Blanchard and Jordi Galí
-
Exogenous Oil Supply Shocks: How Big are They and How Much Do They Matter for the Us Economy?
By Lutz Kilian