More Slides from Ed Dolan’s Econ Blog http://dolanecon.blogspot.com/ Monetary Accommodation of Oil Price Shocks: Some Simp...
To Accommodate or Not to Accommodate? <ul><li>As oil prices spiked in early 2011, inflation rates in the US, the EU, and t...
The Aggregate Supply Curve <ul><li>At any given time, an increase in the price level, other things being equal, will be as...
Effect of an Oil Price Shock on Aggregate Supply <ul><li>An increase in global oil prices causes the AS curve to shift to ...
The Aggregate Demand Curve <ul><li>The effect of monetary policy on the economy can be represented using an aggregate dema...
AS and AD together Determine Prices and Real Output <ul><li>As an approximation, we can treat monetary policy as determini...
Effect of an Oil Shock with Unchanged Policy <ul><li>Suppose monetary policy remains unchanged when an oil price shock shi...
Tightening Policy to Reduce Inflationary Impact of a Shock <ul><li>Instead, the central bank could tighten monetary policy...
Accommodating the Impact of the Oil Price Shock <ul><li>Still another alternative would be to  accommodate  the oil price ...
The Bottom Line <ul><li>There is nothing the central bank of an oil importing country can do to prevent a price shock from...
Upcoming SlideShare
Loading in...5
×

Will Central Banks Accommodate Oil Price Shocks?

1,533

Published on

Oil prices are pushing up inflation. Will the central banks of the United States, the UK, and the euro area tighten monetary policy to resist the effects of the oil price shock, or will they keep policy loose to accommodate it?

Published in: Economy & Finance
0 Comments
1 Like
Statistics
Notes
  • Be the first to comment

No Downloads
Views
Total Views
1,533
On Slideshare
0
From Embeds
0
Number of Embeds
0
Actions
Shares
0
Downloads
10
Comments
0
Likes
1
Embeds 0
No embeds

No notes for slide

Will Central Banks Accommodate Oil Price Shocks?

  1. 1. More Slides from Ed Dolan’s Econ Blog http://dolanecon.blogspot.com/ Monetary Accommodation of Oil Price Shocks: Some Simple Analytics Posted March 24, 2011 Terms of Use: These slides are made available under Creative Commons License Attribution—Share Alike 3.0 . You are free to use these slides as a resource for your economics classes together with whatever textbook you are using. If you like the slides, you may also want to take a look at my textbook, Introduction to Economics , from BVT Publishers.
  2. 2. To Accommodate or Not to Accommodate? <ul><li>As oil prices spiked in early 2011, inflation rates in the US, the EU, and the euro area rose above the 2 percent target rates set by their respective central banks </li></ul><ul><li>Question: </li></ul><ul><ul><li>Should central banks fight oil-price inflation by tightening monetary policy? </li></ul></ul><ul><ul><li>Or should they accommodate the oil price shock, allowing inflation to continue above the target rate? </li></ul></ul><ul><li>This slideshow applies simple macroeconomic analysis to the question of whether to accommodate, or not to accommodate </li></ul>Posted Mar 24, 2011 on Ed Dolan’s Econ Blog http://dolanecon.blogspot.com
  3. 3. The Aggregate Supply Curve <ul><li>At any given time, an increase in the price level, other things being equal, will be associated with an increase in output of real goods and services </li></ul><ul><li>This relationship is known as the aggregate supply curve </li></ul><ul><li>The aggregate supply curve shows only a short-run relationship; in the long run, real GDP tends to revert to a potential level, determined by population and productivity </li></ul>Posted Mar 24, 2011 on Ed Dolan’s Econ Blog http://dolanecon.blogspot.com
  4. 4. Effect of an Oil Price Shock on Aggregate Supply <ul><li>An increase in global oil prices causes the AS curve to shift to the left </li></ul><ul><li>The economy can continue to produce as much as before only if prices increase (Point A) </li></ul><ul><li>The average price level can be held constant only if wages and prices of non-oil inputs fall by enough to offset the increase in oil prices </li></ul><ul><li>That will happen only if real GDP falls by enough to produce excess unemployment and excess capacity (Point B) </li></ul><ul><li>Combinations of these alternatives are also possible, shown by points between A and B </li></ul>Posted Mar 24, 2011 on Ed Dolan’s Econ Blog http://dolanecon.blogspot.com
  5. 5. The Aggregate Demand Curve <ul><li>The effect of monetary policy on the economy can be represented using an aggregate demand curve </li></ul><ul><li>Along the aggregate demand curve nominal GDP remains roughly constant </li></ul><ul><ul><li>If the price level is lower, a given amount of nominal spending can purchase a larger quantity of real goods and services </li></ul></ul><ul><ul><li>If the price level is higher, the same level of nominal spending will purchase a smaller quantity of real goods and services </li></ul></ul><ul><li>This diagram is simplified by drawing the AD curve as a straight line </li></ul>Posted Mar 24, 2011 on Ed Dolan’s Econ Blog http://dolanecon.blogspot.com
  6. 6. AS and AD together Determine Prices and Real Output <ul><li>As an approximation, we can treat monetary policy as determining the position of the AD curve </li></ul><ul><li>The position of the AS curve is determined by the willingness of producers to supply real goods, given prevailing costs and prices </li></ul><ul><li>The intersection of the two curves determines the level of real GDP and the price level at any given time </li></ul>Posted Mar 24, 2011 on Ed Dolan’s Econ Blog http://dolanecon.blogspot.com
  7. 7. Effect of an Oil Shock with Unchanged Policy <ul><li>Suppose monetary policy remains unchanged when an oil price shock shifts the AS curve to the left </li></ul><ul><li>In that case, the economy will tend to move up and to the left along the AD curve, from A to B </li></ul><ul><li>The price level will rise, real output will decrease, and the unemployment rate will increase </li></ul>Posted Mar 24, 2011 on Ed Dolan’s Econ Blog http://dolanecon.blogspot.com
  8. 8. Tightening Policy to Reduce Inflationary Impact of a Shock <ul><li>Instead, the central bank could tighten monetary policy to reduce the inflationary impact of the oil price shock </li></ul><ul><li>Doing so would shift the AD curve to the left, as shown </li></ul><ul><li>The economy would move from A to C instead of from A to B </li></ul><ul><li>In this case, the oil shock would cause less inflation, but it would cause a greater decrease in real GDP and more unemployment </li></ul>Posted Mar 24, 2011 on Ed Dolan’s Econ Blog http://dolanecon.blogspot.com
  9. 9. Accommodating the Impact of the Oil Price Shock <ul><li>Still another alternative would be to accommodate the oil price shock by easing monetary policy </li></ul><ul><li>The AD curve would then shift to the right </li></ul><ul><li>The economy would tend to move from A to D, instead of A to B </li></ul><ul><li>Accommodation would increase the amount of inflation, but it would moderate the impact of the shock on real output and employment </li></ul>Posted Mar 24, 2011 on Ed Dolan’s Econ Blog http://dolanecon.blogspot.com
  10. 10. The Bottom Line <ul><li>There is nothing the central bank of an oil importing country can do to prevent a price shock from harming the economy </li></ul><ul><li>Monetary policy can only affect the way in which the harm is manifested </li></ul><ul><ul><li>With tight money, more unemployment and less real output, but also less inflation </li></ul></ul><ul><ul><li>With accommodation, more inflation, but a smaller impact on real output and employment </li></ul></ul>Posted Mar 24, 2011 on Ed Dolan’s Econ Blog http://dolanecon.blogspot.com
  1. A particular slide catching your eye?

    Clipping is a handy way to collect important slides you want to go back to later.

×