On the effects of an oil price shock.
Matt Yglesias worries about the consequences of an Israel-Iran war, and concludes that, if things are bad now, just wait until we've got inflation to worry about! Except, if we have an oil price shock now, we'd be freed from our liquidity trap. This is the counter-intuitive logic whereby everything that is normally "bad" -- i.e., inflationary -- now helps the economy by reducing real interest rates. The only way an oil shock would hurt is if the Fed overreacts, and raises interest rates prematurely to head off inflation before it comes. This is more than a remote possibility, of course, but an oil price shock would at least get us back to the situation where the Fed can simply cut the federal funds rate when it wants to stimulate the economy rather than play word games with the "extended period" language.
Links for 07-24-17
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