Working Paper 07 - 17 November 2007 Oil and the

Working papers of the Federal Reserve Bank of Cleveland are preliminary materials circulated to stimulate discussion and critical comment on research in progress. They may not have been subject to the formal editorial review accorded offi cial Federal Reserve Bank of Cleveland publications. The views stated herein are those of the authors and are not necessarily those of the Federal Reserve Bank of Cleveland or of the Board of Governors of the Federal Reserve System. We assess the extent to which the period of great U.S. macroeconomic stability since the mid-1980s can be accounted for by changes in oil shocks and the oil share in GDP. To do this we estimate a DSGE model with an oil-producing sector before and after 1984 and perform counterfactual simulations. We nest two popular explanations for the Great Moderation: (1) smaller (non-oil) real shocks; and (2) better monetary policy. We fi nd that the reduced oil share accounted for as much as one-third of the infl ation moderation and 13% of the growth moderation , while smaller oil shocks accounted for 11% of the infl ation moderation and 7% of the growth moderation. This notwithstanding, better monetary policy explains the bulk of the infl ation moderation, while most of the growth moderation is explained by smaller TFP shocks.