Question

8. An oil price shock (hard): Suppose the economy is hit by an unexpected oil price shock that permanently raises oil prices by $50 per barrel. This is a temporary increase in o in the model: the shock o becomes positive for one period and then goes back to zero. (a) Using the full short-run model, explain what happens to the economy in the absence of any monetary policy action. Be sure to include graphs showing how output and inflation respond over time. (b) Suppose you are in charge of the central bank. What monetary policy action would you take and why

Answer 1

An oil cost shock is an exogenous shock and it will in general move the short run total stockpile bend SRAS upwards showing an expanded expense of creation.

a. From introductory balance, value level in the economy for all time rises and this moves the economy to another balance to bring down short-run yield level.

Phillips bend, indicating the impact of swelling, climbs in period one and afterwards moves back. Fisher's condition portrays the reverse connection between genuine loan fee and expansion through ostensible financing cost. On the off chance that the national bank is failing to help controlling swelling, at that point this suggests it needs to keep up the first ostensible financing cost.

This decreases the genuine loan fee when ostensible financing cost is kept unaltered. With LM moving downwards, it animates the economy to an expanding lower level of genuine loan cost as expansion rises for all time.

b. Since an oil value stun upsets the economy through swelling channel, national bank ought to fix the financial arrangement to decrease it for one period. In spite of the fact that this damages the economy all the more however this will last just for one period. As the genuine financing cost ascend in the following time frame, swelling falls and balance in the economy is reestablished.