Earlier we mentioned a Ben Bernanke paper from 1997 titled, Systematic Monetary Policy and the Effects of Oil Price Shocks and while the full thing is definitely worth a read, we have a breakdown for you right here.
CNBC is talking about it today, too, in light of the ECB’s talk of higher rates.
The thesis is that it is central bank monetary policy in reaction to oil price spikes that creates economic downturns, not the oil price spike itself.
Bernanke and his co-authors Mark Gertler and Mark Watson discover, utilising a model that removes either the rate hike or the oil spike from the equation, that, when left alone, the economy actually performs better. Prices go up, yes, but so does output, and things stabilise a bit within 10 months.
On the other hand, a rate hike ends up causing problems for years, reducing output.
The implication of this is that Federal Reserve Chair Ben Bernanke has no interest in raising rate for a commodity or oil spike, so long as prices remain within Fed range, because it has a damaging impact on output that could send unemployment higher.
The recession in 1973-75, 1980-82, and 1990-91 were all preceded by oil price spikes. In fact, every recession in the last 30-years (1967-1997) was preceeded by an oil price spike.
But every recession in this period has also been preceeded by monetary policy tightening, so it is hard to determine causality.
Editor's note: An oil price shock also preceeded the most recent recession.
When looking at just a Fed funds rate hike, Bernanke found that the result of a 25 basis point increase, without an oil price shock, is a decline in the economy that bottoms between 18-24 months. It takes two years for prices to fall. Commodity prices fall more quickly.
The results showed that, two thirds or three fourths of the output impact related to an oil price shock is actually created by monetary policy tightening. The oil price shock, therefore, has a limited and shorter impact.
The 1974-75 recession cannot be explained by the oil price shock alone. Instead, it is better explained by the sharp rise in commodity prices overall. This price rise for the entire sector led to a monetary policy response too, which led to a recession.
Editors note: This may help to explain why Bernanke doesn't consider commodity prices a threat worth dealing with.
Bernanke's model shows that if the Fed does not hike rates during an oil price spike, output is higher.
For the periods 1979-1983 and 1988-1992, Bernanke's model shows that when an increase in the Fed funds rate is excluded, output and prices are higher than when the Fed funds rate is in place.
Conclusion: 'That the greatest portion of the impact of an oil price shock on the real economy is attributable to the central banks response to the inflationary pressures engendered by the shock.'
When commodity prices surge, the Fed typically reacts as well. The result of which is a similar scenario to an oil price spike response: a greater slowdown than necessary. If the Fed doesn't act, prices rise, but output does not contract.
This 1997 paper gives us a look at how Federal Reserve Chairman Ben Bernanke thinks, and it is not at all like his counterpart at the ECB, Jean-Claude Trichet.
Trichet is planning on raising the interest rate at the ECB in an attempt to combat rising prices due to both a commodity price spike and, specifically, a geopolitical driven oil price spike. His job is to focus on price stability alone, and thus he sees an increase in prices beyond the ECB's desired range and must act.
Bernanke, on the other hand, is worried about both inflation and unemployment. Bernanke sees an increase in both commodity prices and oil, driven by increasing demand and geopolitical concerns. He is, however, not interested in raising rates, because that would lead to an unnecessary decline in output which would hit the unemployment rate. Thus, no rate hike from Bernanke will happen as a result of price increases, so long as they remain within Fed range.
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