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Monetary Policy Trade-Offs with a Dominant Oil Producer

Authors


  • We are grateful for helpful comments from and discussions with Jordi Galí, Max Gillman, Fernando Restoy, Charles Carlstrom, Pau Rabanal, Fabio Canova, Morten Ravn, Wouter den Haan, Bruce Preston, and Thijs van Rens, as well as to seminar participants at Universitat Pompeu Fabra, Dynare Conference Paris, ESEM Budapest, and EEA Milan. The views expressed in this paper are those of the authors and do not necessarily reflect the views of Banco de España or the Federal Reserve Bank of Cleveland.

Abstract

We model oil production decisions from optimizing principles rather than assuming exogenous oil price shocks and show that the presence of a dominant oil producer leads to sizable static and dynamic distortions of the production process. Under our calibration, the static distortion costs the U.S. around 1.6% of GDP per year. In addition, the dynamic distortion, reflected in inefficient fluctuations of the oil price markup, generates a trade-off between stabilizing inflation and aligning output with its efficient level. Our model is a step away from discussing the effects of exogenous oil price variations and toward analyzing the implications of the underlying shocks that cause oil prices to change in the first place.

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