118
Brookings
Papers
on
Economic
Activity,
1:1997
show
roughly
similar
departures
from baseline.
Note, however, that the
former cannot distinguish between
policies
that
differ only in the ex-
pected future values
of the
funds
rate, whereas,
in
principle, the latter
approach
can make that distinction.
The results of figure 4 are
reasonable, with all variables exhibiting
their
expected qualitative behaviors.
In
particular, the absence of an
endogenously restrictive
monetary policy
results in
higher output and
prices, as one would anticipate.
Quantitatively,
the
effects are large, in
that
a
nonresponsive monetary
policy
suffices to
eliminate most of
the
output
effect of an oil
price
shock, particularly
after the first
eight to
ten months. The conclusion that
a
substantial
part
of the
real
effects of
oil
price shocks
is due to the
monetary policy response helps
to
explain
why the effects of these shocks
seems
larger
than can
easily be ex-
plained
in
neoclassical (flexible
price)
models.42
The anticipated policy
simulation results
in
modestly higher output
and
price responses
than the Sims-Zha simulation
in
figure
4. The
differences
in
results
occur
largely
because the
anticipated policy
sim-
ulation involves a
negative
short-run
response
in
both the
short and
long
term
premiums,
and thus
lower interest
rates in
the
short run.
Figure
5
repeats
the
anticipated policy
simulation
of
figure 4,
but with
the re-
sponse of the term premiums
shut
off;
that
is,
the
funds rate
is
allowed
to affect the macroeconomic
variables
only through
its
effects on the
expectations component
of market rates.
This
alternative
simulation
attributes somewhat
less
of
the recession
that follows an oil
shock
to
the
monetary policy response,
but
endogenous monetary policy
still
accounts for two-thirds
to three-fourths
of
the total
effect
of
the oil
price
shock
on
output.
As
another exercise
in counterfactual
policy simulation,
we exam-
ine
the three
major
oil
price
shocks followed
by
recessions:
OPEC
1,
OPEC
2,
and the
Iraqi
invasion
of Kuwait.
Figure
6
shows
the
results,
focusing
on
the behavior
of
three
key
variables
(output,
the
price level,
and the funds
rate)
for
the
five-year
periods surrounding
each
of these
episodes (respectively, 1972-76,
1979-83,
and
1988-92).
Each
panel
shows
three
paths
of the
given
variable. One line
depicts
the
actual
historical
path
of
the
variable. The line
marked "federal
funds
endog-
42. It should be emphasized
that
we
are not
arguing
that the policies actually fol-
lowed by the Fed
in
the face of
oil shocks were
necessarily
suboptimal; the usual output-
inflation trade-off is present in our simulations,
and
we
do not
attempt
a
welfare analysis.