Working Paper: CEPR ID: DP7324
Authors: Lutz Kilian
Abstract: One of the central questions in recent macroeconomic history is to what extent monetary policy as opposed to oil price shocks contributed to the stagflation of the 1970s. Understanding what went wrong in the 1970s is the key to learning from the past. One explanation explored in Barsky and Kilian (2002) is that worldwide shifts in monetary policy regimes not related to the oil market played a major role in causing both the major oil price increases of the 1970s and stagflation in many economies. A competing view exemplified by Bernanke, Gertler and Watson (1997) is that the oil price shocks of the 1970s and 1980s arose exogenously with respect to global macroeconomic conditions, but were propagated by the reaction of monetary policy makers, causing stagflation in the process. This paper reviews the evidence for these two main explanations, interprets recent events in light of this evidence, and outlines implications for monetary policy.
Keywords: monetary policy; oil price; policy reaction; regimes; stagflation
JEL Codes: E31; E32; E42; Q43
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| shifts in monetary policy regimes (E63) | oil price increases (Q31) |
| shifts in monetary policy regimes (E63) | stagflation (E65) |
| oil price increases (Q31) | stagflation (E65) |
| reaction of monetary policymakers to inflationary pressures from oil price shocks (E31) | stagflation (E65) |
| policymakers raising interest rates in response to inflation (E52) | deepened recession (F44) |
| partial success of policymakers in controlling inflation (E64) | stagflation (E65) |
| recent oil price shocks driven by structural economic changes in emerging Asia (N15) | absence of stagflation (E65) |
| improved monetary policy responses (E63) | absence of stagflation (E65) |
| credibility of central banks in maintaining price stability (E58) | occurrence of stagflation (E65) |