Oil Price Shocks and Cyclical Dynamics in an Asymmetric Monetary Union

Abstract

This paper analyzes the dynamic effects of anticipated and unanticipated oil price increases in a small two-country monetary union, which is simultaneously characterized by asymmetric wage adjustments and asymmetric interest rate sensitivities of private absorption. Common external oil price disturbances lead in this asymmetric macroeconomic setup to temporary divergences in output developments across the monetary union. In the case of anticipated oil price increases the relative cyclical position is reversed in the course of the adjustment process. Complete stabilization of the output variables throughout the overall adjustment process requires a restrictive monetary policy being time inconsistent from a quantitative but time consistent from a qualitative point of view. That means that the central bank credibly announces a future reduction in the growth rate of the nominal money stock but actually implements a reduction, which is less restrictive than the original announcement.

Keywords: EMU, international policy transmission, oil price shock, time inconsistency

JEL Classification: E63, F41