Monetary Policy Responses to Oil Price Fluctuations

52 Pages Posted: 4 Apr 2012

See all articles by Martin Bodenstein

Martin Bodenstein

affiliation not provided to SSRN

Luca Guerrieri

Federal Reserve Board - Trade and Financial Studies

Lutz Kilian

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

Date Written: April 2012

Abstract

The recent volatility in global commodity prices and in the price of oil, in particular, has created renewed interest in the question of how monetary policy makers should respond to oil price fluctuations. In this paper, we discuss why this question is ill-posed and has no general answer. The central message of our analysis is that the best central bank policy response to oil price fluctuations depends on why the price of crude oil has changed. For example, an unexpected oil supply disruption in the Middle East calls for a different policy response than an unexpected increase in Chinese productivity or oil intensity. This means that policy makers need to disentangle the structural shocks that are jointly driving the price of oil and the macroeconomy and tailor their response to the observed mix of shocks. We use a multi-country DSGE model to quantify the appropriate policy responses and to analyze the optimal responses from a welfare point of view. We also reexamine the welfare gains from global monetary policy coordination in a world with trade in oil.

Keywords: endogeneity, global economy, monetary policy, oil price, open economy, policy rule, welfare

JEL Classification: E32, E43, F32, Q43

Suggested Citation

Bodenstein, Martin and Guerrieri, Luca and Kilian, Lutz, Monetary Policy Responses to Oil Price Fluctuations (April 2012). CEPR Discussion Paper No. DP8928. Available at SSRN: https://ssrn.com/abstract=2034146

Martin Bodenstein (Contact Author)

affiliation not provided to SSRN ( email )

Luca Guerrieri

Federal Reserve Board - Trade and Financial Studies ( email )

20th St. and Constitution Ave.
Washington, DC 20551
United States
202-452-2550 (Phone)

Lutz Kilian

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

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