Managing an Energy Shock: Fiscal and Monetary Policy
This paper revisits the macroeconomic effects of energy price shocks in energy-importing economies. In standard representative-agent models, increases in energy prices trigger a boom in aggregate demand by reallocating spending towards domestic production. In heterogeneous-agent models, by contrast, we show that they cause a recession by pushing down on real wages and therefore on consumer spending, provided that the elasticity of substitution between energy and domestic goods is realistically low. Imported energy inﬂation can spill over to wage inﬂation through a wage-price spiral, without mitigating the real wage decline. Monetary policy tightening has limited effect on imported inﬂation when done in isolation, but can be powerful when done in conjunction with other energy importers by lowering world energy demand. Fiscal policy, especially energy price subsidies, can isolate individual energy importers from the shock, but it has large negative externalities on other economies.