Monetary Policy Trade‐Offs with a Dominant Oil Producer

Abstract

We model oil production decisions from optimizing principles rather than assuming exogenous oil price shocks and show that the presence of a dominant oil producer leads to sizable static and dynamic distortions of the production process. Under our calibration, the static distortion costs the U.S. around 1.6% of GDP per year. In addition, the dynamic distortion, reflected in inefficient fluctuations of the oil price markup, generates a trade‐off between stabilizing inflation and aligning output with its efficient level. Our model is a step away from discussing the effects of exogenous oil price variations and toward analyzing the implications of the underlying shocks that cause oil prices to change in the first place.

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