World Crude Oil Markets: Monetary Policy and the Recent Oil Shock
IMF Working Papers, March 1, 2006
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- World Crude Oil Markets: Monetary Policy and the Recent Oil Shock
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Bibliographic details
- Authors: Noureddine Krichene
- Published: March 1, 2006
- Series: IMF Working Papers
- DOI: https://doi.org/10.5089/9781451863222.001
Summary
- Examines the relationship between monetary policy and oil prices within a world oil demand and supply model.
- Low price and high income elasticities of demand and rigid supply explain high price volatilities and producers' market power.
- Exchange and interest rates influence oil market equilibrium.
- The relationship between oil prices and interest rates is two-way and depends on the type of oil shock:
- During a supply shock, rising oil prices caused interest rates to increase.
- During a demand shock, falling interest rates caused oil prices to rise.
- Record low interest rates led to high oil price volatility in 2005.
- Concludes that world economic growth and price stability require stable oil markets and therefore more prudent monetary policies.
Key Findings and Mechanisms
- Demand-side characteristics:
- Low price elasticity of demand.
- High income elasticity of demand.
- Supply-side characteristics:
- Rigid supply contributing to price volatility.
- Producers’ market power amplifies price movements.
- Role of macro-financial variables:
- Exchange rates affect oil market equilibrium.
- Interest rates enter a bi-directional relationship with oil prices, with causality depending on whether shocks are supply- or demand-driven.
- Historical observation:
- Record low interest rates in 2005 are associated with heightened oil price volatility.
Policy Implications
- Stable oil markets are necessary for:
- Sustainable world economic growth.
- Price stability.
- Monetary policy recommendations:
- Adopt more prudent monetary policies to reduce oil market volatility and support global growth and price stability.