Hedging Oil Shocks in Monetary Policy

Abstract

Significant fluctuations in crude oil prices draw attention from policymakers, academics, and practitioners. These fluctuations often arise from global demand changes, supply disruptions, or precautionary motives, prompting critical questions about monetary policy responses. Understanding the interplay between oil shocks and monetary policy requires examining central bank actions and their economic impacts. This study investigates monetary policy responses to oil shocks since the 1990s using Structural Vector Autoregression, Impulse Response Functions, and Variance Decomposition. These methods reveal dynamic relationships between crude oil prices, inflation rates, and monetary policy rates. The findings highlight distinct responses among countries. Major oil importers like the U.S. and China significantly raise policy rates in response to oil shocks, while Japan shows a more modest reaction. Among oil-exporting nations, Saudi Arabia and Canada respond swiftly and substantially, whereas Nigeria adopts an unconventional approach, loosening monetary policy after an oil shock. These variations underscore the complex interactions between oil prices and monetary policy globally.