Monetary policy and oil price expectations

Abstract

This article provides robust estimates that the Bank of Canada, Bank of England, Federal Reserve Bank and the European Central Bank (ECB) respond to a 1% increase in oil price expectations with an increase in the interest rate of on average about 11 basis points. To correctly assess the information set of a central bank we use private sector forecasts and disentangle oil price expectations from inflation expectations. We also find asymmetries in the central bank's behaviour and report that those central banks do not respond to the realized oil price.

Keywords:

• monetary policy
• oil price
• Taylor rule
• expectations

JEL Classification:

• E52
• D84
• Q47

Acknowledgements

We are grateful to Helge Berger, Jörg Breitung, Jordi Galí, Thomas Laubach, Eric M. Leeper, Hashem Pesaran, Jan-Egbert Sturm and participants of an internal seminar at the European Central Bank (ECB) for helpful discussions and comments of an earlier draft of this article. Any remaining errors are ours alone.

Notes

¹ Our sample period ends in 2007 to separate the impact of oil price shocks from the influence of the economic and financial crisis 2008–2009.

² The participants are professional economists working for universities and financial institutions such as international economic research institutes, investment and commercial banks. Further information concerning the survey can be found on the website: www.consensuseconomics.com.

³ Since stationarity is a prerequisite to estimate Taylor rules to avoid the spurious regression problem (Österholm, 2005), we tested for stationarity in our data which cannot be rejected on a 1% level.

⁴ To use a consistent data set, we followed Orphanides (2003), McCallum and Nelson (1999) and Levin et al. (1999, 2003) and applied the output growth forecasts rather than the output gap. VAR-based results on the output gap are similar and available upon request.

⁵ Results based on Ordinary Least Squares (OLS), Seemingly Unrelated Regression Estimator (SURE) and panel fixed effects are similar and available upon request.