Systematic Monetary Policy and the Effects of Oil Price Shocks

Systematic Monetary Policy and the Effects of Oil Price Shocks

1:1997 | Ben S. Bernanke, Mark Gertler, Mark Watson
This paper examines the role of monetary policy in postwar U.S. business cycles, focusing on the effects of oil price shocks. The authors use vector autoregressions (VARs) to analyze the relationship between monetary policy and macroeconomic variables. They find that shocks to monetary policy explain relatively little of the variation in output, typically less than 20 percent. However, they also note that most movements in monetary policy instruments are endogenous, meaning they are influenced by macroeconomic conditions. This suggests that systematic monetary policy, rather than erratic fluctuations, may have a significant impact on the economy. The paper discusses the challenges of measuring the effects of monetary policy rules on the economy, particularly in the context of oil price shocks. The authors argue that oil price shocks are a key factor in postwar U.S. recessions, as they have preceded major recessions such as those in 1973–75, 1980–82, and 1990–91. They also note that oil price shocks may confound the effects of monetary tightening. The authors use a modified VAR framework to identify the effects of oil price shocks and their interaction with monetary policy. They find that endogenous monetary policy can account for a substantial portion of the depressing effects of oil price shocks on the real economy. They also show that their method produces reasonable results when applied to the analysis of monetary policy reactions to other types of shocks, such as shocks to output and commodity prices. The paper highlights the difficulty of identifying the effects of oil price shocks in a VAR context, as no single indicator consistently produces the expected responses of macroeconomic variables. The authors choose the "net oil price increase" variable proposed by Hamilton as their principal measure of oil price shocks. They find that this measure produces reasonable results for the analysis of shocks to monetary policy and to oil prices. The paper also discusses the challenges of measuring the effects of endogenous monetary policy, noting that the Lucas critique suggests that policy changes may not have the same effects over time. However, the authors argue that their method provides a reasonable approximation of the effects of anticipated policy changes. Overall, the paper finds that oil price shocks are a significant factor in postwar U.S. recessions, but that endogenous monetary policy also plays an important role. The authors conclude that both factors contribute to economic fluctuations, and that understanding their interaction is crucial for analyzing the effects of monetary policy on the economy.This paper examines the role of monetary policy in postwar U.S. business cycles, focusing on the effects of oil price shocks. The authors use vector autoregressions (VARs) to analyze the relationship between monetary policy and macroeconomic variables. They find that shocks to monetary policy explain relatively little of the variation in output, typically less than 20 percent. However, they also note that most movements in monetary policy instruments are endogenous, meaning they are influenced by macroeconomic conditions. This suggests that systematic monetary policy, rather than erratic fluctuations, may have a significant impact on the economy. The paper discusses the challenges of measuring the effects of monetary policy rules on the economy, particularly in the context of oil price shocks. The authors argue that oil price shocks are a key factor in postwar U.S. recessions, as they have preceded major recessions such as those in 1973–75, 1980–82, and 1990–91. They also note that oil price shocks may confound the effects of monetary tightening. The authors use a modified VAR framework to identify the effects of oil price shocks and their interaction with monetary policy. They find that endogenous monetary policy can account for a substantial portion of the depressing effects of oil price shocks on the real economy. They also show that their method produces reasonable results when applied to the analysis of monetary policy reactions to other types of shocks, such as shocks to output and commodity prices. The paper highlights the difficulty of identifying the effects of oil price shocks in a VAR context, as no single indicator consistently produces the expected responses of macroeconomic variables. The authors choose the "net oil price increase" variable proposed by Hamilton as their principal measure of oil price shocks. They find that this measure produces reasonable results for the analysis of shocks to monetary policy and to oil prices. The paper also discusses the challenges of measuring the effects of endogenous monetary policy, noting that the Lucas critique suggests that policy changes may not have the same effects over time. However, the authors argue that their method provides a reasonable approximation of the effects of anticipated policy changes. Overall, the paper finds that oil price shocks are a significant factor in postwar U.S. recessions, but that endogenous monetary policy also plays an important role. The authors conclude that both factors contribute to economic fluctuations, and that understanding their interaction is crucial for analyzing the effects of monetary policy on the economy.
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Understanding Systematic Monetary Policy and the Effects of Oil Price Shocks