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OIL SHOCKS AND OPTIMAL MONETARY POLICY

Published online by Cambridge University Press:  05 January 2012

Carlos Montoro
Carlos Montoro*
Affiliation:
Banco Central de Reserva del Perú, Bank for International Settlements and CENTRUM Católica
*
Address correspondence to: Carlos Montoro, Office for the Americas, Bank for International Settlements, Torre Chapultepec—Rubén Darío 281–1703, Col. Bosque de Chapultepec 11580, México DF, México; e-mail: carlos.montoro@bis.org, carlos.montoro@pucp.edu.pe.
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Abstract

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This paper studies how monetary policy should react to oil shocks in a microfounded model with staggered price-setting and oil as an input in a CES production function. In particular, we extend Benigno and Woodford [Journal of the European Economic Association 3 (6) (2005), 1–52] to obtain a second-order approximation to the expected utility of the representative household when the steady state is distorted and the economy is hit by oil price shocks. The main result is that oil price shocks generate an endogenous trade-off between inflation and output stabilization when oil has low substitutability in production. We also find, in contrast to Benigno and Woodford, that this trade-off is reduced, but not eliminated, when we get rid of the effects of monopolistic distortions in the steady state. Moreover, the size of the endogenous “cost-push” shock generated by fluctuations in the oil price increases when it is more difficult to substitute other factors for oil.

Keywords

Optimal Monetary PolicyWelfareSecond-Order SolutionOil Price ShocksEndogenous Trade-Off

Information

Type
Articles
Information
Macroeconomic Dynamics , Volume 16 , Issue 2 , April 2012, pp. 240 - 277
Copyright
Copyright © Cambridge University Press 2011

References

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