| Traditional literature on energy economics gives a central role to exogenous political events (supply shocks) or to global economic growth (aggregate demand shock) in modeling the oil market. However, more recent literature claims that the increased precautionary demand for oil triggered by increased uncertainty about a future oil supply shortfall is also driving the price of oil. The intuition for the precautionary demand motive is that since firms, using oil as an input in their production process, are concerned about the future oil prices, it is reasonable to think that in the case of uncertainty about future oil supply (such as a highly expected war in the Middle East), they will buy futures and/or forward contracts to guarantee a future price and quantity. We find that under baseline Taylor-type interest rate rule, real oil prices, inflation and output loss overshoot and go down below their steady state values at the next period if uncertainties are not realized. However, if the shock is realized, i.e. followed by an actual supply shock, the effect on inflation and output loss is high and persistent. Second chapter analyzes the implications of storage market for the monetary policy formulation as a response to an oil price shock. Recent literature suggests that although high oil prices contributed to recessions, they never had a pivotal role in the creation of those economic downturns. A general consensus is that the decline in output and employment was due to the rise in interest rates, resulting from the Fed's endogenous response to higher inflation induced by oil price shocks. However, traditional literature assumes that oil price shocks are exogenous to the U.S economy and ignores the storage market for crude oil. In this regard, a model with an endogenous (demand shock) or exogenous (supply shock) price shock may produce a totally different monetary policy proposal when a market for crude oil storage exists. The rationale behind this idea is that when goods prices are sticky in the economy, the monetary authority can affect the level of inventories through changes in real interest rates. Thus, lower interest rate rules, as proposed in the literature, will cause additional oil supply scarcity in the spot market. Therefore, an optimal monetary policy that maximizes the welfare in the economy should consider the adverse affect of low interest rates on the crude oil market. |
