Oil price shock and monetary policy in the Nordic : a study of Denmark, Norway and Sweden

Abstract

This paper examines the effect of an oil price shock on three Nordic countries, distinguishing between oil-exporting and oil-importing countries, and how their monetary policies respond to the shock. The central banks respond to how the oil price increase transmits through the economy and hence an analysis of the response of other macroeconomic variables is outlined. The channel of influence of an oil price increase may be many so a vector autoregression (VAR) technique is chosen in order to examine the macroeconomic effects in each country. Oil-exporting countries are expected to benefit from an oil price shock which this study confirms. The oil-importing country also shows a positive impact on economic activity after an oil shock, which might be due to the close ties to the oil-exporting countries and a reduction in oil-dependency. The countries adopting flexible exchange rate regimes are expected to experience higher increase in price level, however in Norway this is mitigated through the “Government Pension Fund” which prevents increased oil revenues to fuel inflation. As oil shocks are considered inflationary, all countries respond by increasing the short term interest rate, whereas for the flexible exchange rate regimes the appreciation of the currency is the variable offsetting the inflationary pressure.