Monetary Policy Responses to Oil Price Fluctuations

52 Pages Posted: 4 Apr 2012

See all articles by Martin Bodenstein

Martin Bodenstein

Board of Governors of the Federal Reserve System

Luca Guerrieri

Board of Governors of the Federal Reserve System

Lutz Kilian

Federal Reserve Banks - Federal Reserve Bank of Dallas; 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)

Board of Governors of the Federal Reserve System ( email )

Luca Guerrieri

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States
202-452-2550 (Phone)

Lutz Kilian

Federal Reserve Banks - Federal Reserve Bank of Dallas ( email )

2200 North Pearl Street
PO Box 655906
Dallas, TX 75265-5906
United States

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

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