Oil Price Shocks and Monetary Policy : The Role for Storage

Some recent literature suggests that although high oil prices contributed to recessions, they have 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 Feds endogenous response to the higher inflation induced by oil price shocks. However, traditional literature assumes that oil price shocks are exogenous to the U.S economy and they ignore the storage market for the 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 there exists a market for storage for the crude oil. The rationale behind this idea is that when goods' prices are sticky in the economy, the monetary authority can effect the level of inventories through the changes in the 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