Oil Market Changes, the Global
Economy, and Monetary Policy
Jeffrey Frankel
IMF-CFR Discussion,
Washington, DC, May 18, 2015
Interrelated causes of 2014 fall in $ oil prices
Recognition of Saudi loss of monopoly power
Technical revolution
in fracking etc.
Stronger US ec. growth
End of US monetary
easing (QE)
Fall in $
oil price
Appreciation of $,
vs. €, ¥,…
Weaker ec.
growth &
inflation in €Z,
Japan, China…
Renewed monetary
easing (QE) in €Z,
Japan, EMs…
Assume a small open economy
facing an exogenous fall in $ oil prices.
Desirable monetary
response ?
Oil importer, experiencing Oil exporter experiencing
favorable Δ terms of trade worsened Δ terms of t.
with respect to external => Money should be
balance: accommodate tight enough that
terms of trade.
currency appreciates.
=> Money should be
loose enough that
currency depreciates.
with respect to internal => Allow some rise in GDP => Mitigate fall in GDP.
& some fall in CPI (so long Overall inflation should
balance.
as W and inflation
expectations anchored),
rise a little (so long as infl.
expectations anchored),
To keep expectations anchored, it would help if these responses took
place within a transparent regime, such as an annual announced
target for some nominal variable. But which variable?
Actual response implied by 4 alternate monetary regimes
Response, Oil importer, experiencing Oil exporter experiencing
if rule is: favorable Δ terms of trade worsened Δ terms of trade
Target
headline
CPI
=>
M is loose enough that currency Same M ease & depreciation.
depreciates by Δp x (oil consumed share of TG ). Direction is now right. But not
Direction is wrong.
enough. Fall in GDP > under GDP deflator target.
oil
c
Target core Little or no depreciation.
Better than headline target.
CPI =>
Little or no depreciation.
Fall in GDP even bigger.
Target GDP Little or no depreciation.
deflator => Better than headline target.
M is loose enough that currency
depreciates by Δp x (oil output share of TG).
Target
Nominal
GDP =>
oil
I.e., more than under CPI target.
No currency depreciation.
Bigger depreciation, enough to allow
Meets objectives better than CPI some P inflation rather than taking
target.
entire shock as fall in real GDP.
Better than CPI target.