Oil prices and the recent rise in inflation
In this paper, Gagliardone and Gertler examine the role the rise in oil prices played in the recent sudden and persistent rise in inflation. They develop a New Keynesian framework with only consumption goods. In particular, oil is both a consumption good and input to production and a complement to other consumption goods and production inputs such as labor. They model unemployment as a function of search and matching in the labor market to capture market tightness as a source of inflation. Finally, the model includes habit formation and real wage rigidity. The authors look at the impact two factors played on the persistence of the current rise in inflation, namely: the dramatic increase in oil prices which began in the summer of 2021 and accelerated in early 2022 in response to the Ukraine war; and, the easy monetary policy in the form of the delayed response of the Federal Reserve to increasing inflation in 2021.
We show that mainly accounting for this [inflation] surge was a combination of oil price shocks and “easy” monetary policy, even after allowing for demand shocks and shocks to labor market tightness. A strong production complementarity between oil and labor, in conjunction with wage rigidity, is important for the quantitative impact of the oil price shock. Also playing a role is the short run trade-off between unemployment and inflation that arises from real wage rigidity, which may account for the degree of central bank’s accommodation of inflation over this period.
Oil Prices, Monetary Policy and Inflation Surges
Authors: Luca Gagliardone, Mark Gertler
From: New York University
The impact of oil price caps on the global oil market
On December 5, 2022, the Price Cap Coalition, consisting of the G7, the European Union, and Australia, imposed a cap on the price of seaborne Russian oil sold into global markets: companies based in coalition countries are currently allowed to provide services that support Russian oil sales, including shipping, insurance and trade finance, but only if the price paid to Russia does not exceed $60 per barrel. What was the impact of this policy on Russia and the global oil markets? This is the question Johnson et al. explore in this paper. They develop a dynamic equilibrium model where a financially constrained exporter of a non-renewable resource optimally exerts market power, and the price of the resource varies stochastically. An important insight from this framework is that the producer’s supply curve is inelastic and, for plausible parameters, may be downward sloping so it might be optimal to increase production when faced with a lower price of oil, as evidenced by a negative correlation between the price of oil and Russian extraction.
Contrary to the fears that an introduction of the price cap will cause a damaging oil supply shock, the exporter may have strong incentives to increase extraction following the introduction of a binding price cap. In fact, when the producer is large and has market power, a price cap that applies to all or most sales significantly limits the degree to which market power is used in equilibrium and stabilizes world oil prices. But if the cap is poorly enforced, or if the sanctioned state has access to a noncompliant “shadow” fleet, the cap is less effective at stabilizing world prices.
A Theory of Price Caps on Non-Renewable Resources
Authors: Simon Johnson, Lukasz Rachel, Catherine Wolfram
From: MIT, UCL, Harvard University
