Analyse manipulating monetary policy, Macroeconomics

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Buckley (2009) writes that the UK was in recession for several short periods during this time, which placed further emphasis on researchingrelationships between the price of oil and key macroeconomic variables in the hope that once a relationship was found, correct measures could be taken to deal with a future oil price shock. Hamilton (1983) produced a paper which analysed the effects of oil price shocks on Gross National Product (GNP) in the United States of America (USA) using data from the period 1948 to 1972. He concluded that GNP would decrease after a period of a sudden increase in oil prices. Further to this, Hamilton claimed that attributing his results to completely random correlations between the variables would be incredibly naïve and irrational. Hamilton's conclusions were unchallenged and were actually supported by other economists. Significantly Burbridge et al (1984) found similar evidence for this relationship in Japan. The fact that this had been proven in a completely different economy supports Hamilton's idea that one must not assume these correlations are random.

Opposition arrived in the form of Mork (1989). Mork's challenge was based around the robustness of the relationship between oil price shocks and GNP. Mork did not challenge the notion that when oil prices increase, GNP decreases. However through his work it was noted that during the late 1980's when oil prices were declining, there was no evidence of GNP increasing. Therefore an extension to Hamilton's theory was created. Mork concluded that the relationship between oil prices and GNP is asymmetrical.

Lee and Ni (1995) supported Mork's results, and from this they used a non-linear transformation of oil prices, called scaled specification, which re-established the negative relationships between the two. To support this, they analysed the Granger Causality between the two variables, in order to create a better understanding of the relationship.

Jiménez-Rodríguez, R. and Sánchez, M. (2004) found evidence which opposes the findings of Mork. Jiménez-Rodríguez and Sánchez. They are researchers for the European Central Bank who found significant evidence that in the UK, when there was a period of oil price reduction, GNPdid the reverse, and increased.

A different strand of research was conducted by different economists and academics. The method was to analyse manipulating monetary policy in order to counteract or at least dampen the effects on the economy from an oil price shock. Bernanke et al (1997) were the first to analyse this. Their results concluded that during the 1970's in the USA, monetary policy played a stabilising role during the aftershocks of an oil price increase, helping to limit the negative effects on economic performance. This methodology complements the VAR model nicely as it analyses policies, which the VAR cannot do. Barsky and Kilian (2004) followed this researchand suggested a similar strategy,that interest rates should be lowered to aim to minimise the effects of the negative relationship between oil prices and GNP. This would make money and credit cheaper to households and firmsand would provide great relief for those who had been considerably affected by the hike in oil prices.

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