Does the Fed Respond to Oil Price Shocks?

45 Pages Posted: 11 Jan 2010

See all articles by Lutz Kilian

Lutz Kilian

University of Michigan at Ann Arbor - Department of Economics; Centre for Economic Policy Research (CEPR)

Logan T. Lewis

Federal Reserve Board, Trade and Quantitative Studies

Multiple version iconThere are 2 versions of this paper

Date Written: December 2009

Abstract

Since Bernanke, Gertler and Watson (1997), a common view in the literature has been that systematic monetary policy responses to the inflation triggered by oil price shocks are an important source of aggregate fluctuations in the U.S. economy. We show that there is no evidence of systematic monetary policy responses to oil price shocks after 1987 and that this lack of a policy response is unlikely to be explained by reduced real wage rigidities. Prior to 1987, according to standard VAR models, the Federal Reserve was not responding to the inflation triggered by oil price shocks, as commonly presumed, but rather to the oil price shocks directly, consistent with a preemptive move by the Federal Reserve to counteract potential inflationary pressures. There are indications that this response is poorly identified, however, and there is no evidence that this policy response in the pre-1987 period caused substantial fluctuations in the Federal Funds rate or in real output. Our analysis suggests that the traditional monetary policy reaction framework explored by BGW and incorporated in subsequent DSGE models should be replaced by DSGE models that take account of the endogeneity of the real price of oil and that allow policy responses to depend on the underlying causes of oil price shocks.

Keywords: Counterfactual, Oil, Recessions, Systematic Monetary Policy, Temporal Instability

JEL Classification: E31, E32, E52, Q43

Suggested Citation

Kilian, Lutz and Lewis, Logan T., Does the Fed Respond to Oil Price Shocks? (December 2009). CEPR Discussion Paper No. DP7594. Available at SSRN: https://ssrn.com/abstract=1533199

Lutz Kilian (Contact Author)

University of Michigan at Ann Arbor - Department of Economics ( email )

611 Tappan Street
Ann Arbor, MI 48109-1220
United States
734-764-2320 (Phone)
734-764-2769 (Fax)

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Logan T. Lewis

Federal Reserve Board, Trade and Quantitative Studies ( email )

20th St. and Constitution Ave.
Washington, DC 20551
United States

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