Skip to main content


  • Yunqing Wang (a1), Qigui Zhu (a2) and Jun Wu (a1)

This paper proposes a New Keynesian dynamic stochastic general equilibrium model of the Chinese economy incorporating the demand of oil to study the effects of oil price shocks on the business cycle. The model answers several questions, including how monetary policy should respond to the disturbances from such shocks, and whether monetary authorities should use core inflation or headline inflation including oil price inflation as the monetary policy rule. The contributions could be summarized as follows: First, the model reveals that the oil transmission mechanism is determined by the nominal inertia, income effect, and the portfolio allocation effect. Second, both noncore inflation monetary policy and core inflation monetary policy that are simultaneously pegged to oil prices fluctuations are inferior to the monetary policy purely pegged to core inflation. Our findings suggest that the monetary policy should focus on core inflation instead of headline inflation.

Corresponding author
Address correspondence to: Yunqing Wang, School of International Finance, Shanghai Finance University, Room 705, East Sub-building, Guanghua Tower, Fudan University, 220 Handan Road, Shanghai 200433, China; e-mail:
Hide All

We are thankful for the useful comments from the editor and two referees. This work is supported by the Project of the National Social Science Fund of China (15CJY064), Project of Humanities and Social Sciences for the Youth in Ministry of Education of China (14YJC790129), Project of Scientific Research in Shanghai Finance University (SHFUKT15-01) and Major Project of the National Social Science Fund of China (14ZDA013).

Hide All
Arora, Vipin, Gomis-Porqueras, Pedro, and Shi, Shuping (2013) The divergence between core and headline inflation: Implications for consumers' inflation expectations. Journal of Macroeconomics 38, 497504.
Bernanke, Ben S., Gertler, Mark, and Watson, Mark (2004) Oil shocks and aggregate macroeconomic behavior: The role of monetary policy. Journal of Money, Credit and Banking 36, 287291.
Bernanke, Ben S., Gertler, Mark, Watson, Mark, Sims, Christopher A., and Friedman, Benjamin M. (1997) Systematic monetary policy and the effects of oil price shocks. Brookings Papers on Economic Activity 1, 91142.
Bodenstein, Martin, Erceg, Christopher J., and Guerrieri, Luca (2008) Optimal monetary policy with distinct core and headline inflation rates. Journal of Monetary Economics 55, S18S33.
Calvo, Guillermo A. (1983) Staggered prices in a utility maximizing framework. Journal of Monetary Economics 12 (3), 383398.
Carlstrom, Charles T. and Fuerst, Timothy Stephen (2006) Oil price, monetary policy, and counterfactual experiments. Journal of Money, Credit and Banking 38 (7), 19451958.
Chen, Qianying, Funke, Michael, and Paetz, Michael (2012) Market and Non-Market Monetary Policy Tools in a Calibrated DSGE Model for Mainland China. BOFIT discussion paper no. 16, Bank of Finland.
Chen, Shu-Hua (2015) Macroeconomic (in) stability of interest rate rules in a model with banking system and reserve markets. Macroeconomic Dynamics 19 (07), 14761508.
Clarida, Richard, Gali, Jordi, and Gertler, Mark (2000) Monetary policy rules and macroeconomic stability: Evidence and some theory. The Quarterly Journal of Economics 1, 147180.
Dhawan, Rajeev and Jeske, Karsten (2007) Taylor Rules with Headline Inflation: A Bad Idea. Working paper no. 14, Federal Reserve Bank of Atlanta.
Eckstein, Otto (1981) Core Inflation. New York: Prentice Hall.
Erceg, Christopher J., Henderson, Dale W., and Levin, Andrew T. (2000) Optimal monetary policy with staggered wage and price contracts. Journal of Monetary Economics 46 (2), 281313.
Finn, Mary G. (1991) Energy Price Shocks, Capital Utilization, and Business Cycle Fluctuations. Discussion paper no. 50, Institute for Empirical Macroeconomics, Federal Reserve Bank of Minneapolis.
Finn, Mary G. (1995) Variance properties of Solow's productivity residual and their cyclical implications. Journal of Economic Dynamics and Control 19 (5), 12491281.
Finn, Mary G. (2000) Perfect competition and the effects of energy price increases on economic activity. Journal of Money, Credit and Banking 32 (3), 400416.
Gong, Liutang and Xie, Danyang (2004) Factor mobility and dispersion in marginal products: A case on China. Economic Research Journal 1, 4553 (in Chinese).
Hou, Chenqi and Gong, Liutang (2013) A review of core inflation theory. China Economic Quarterly 12 (2), 449576 (in Chinese).
Huang, Zelin (2005) A study on business cycle and the effects of fiscal policy in China: An empirical study on a RBC model with three sections. Economic Research Journal 6, 2739 (in Chinese).
Huynh, Bao Tan (2014) Monetary Policy and Energy Price Shocks. Manuscript, Singapore Management University.
Huynh, Bao Tan (2016) Macroeconomic effects of energy price shocks on the business cycle. Macroeconomic Dynamics 20 (03), 623642.
Kilian, Lutz (2008) The economic effects of energy price shocks. Journal of Economic Literature 46 (4), 871909.
Kilian, Lutz (2009) Not all oil price shocks are alike: Disentangling demand and supply shocks in the crude oil market. American Economic Review 99 (3), 10531069.
Kim, In-Moo and Loungani, Prakash (1992) The role of energy in real business cycle models. Journal of Monetary Economics 29 (2), 173189.
Kormilitsina, Anna (2011) Oil price shocks and the optimality of monetary policy. Review of Economic Dynamics 14 (1), 199223.
Kydland, Finn E. and Prescott, Edward C. (1982) Time to build and aggregate fluctuations. Econometrica 50 (6), 13451370.
Le, Vo Phuong Mai Le, Matthews, Kent, Meenagh, David, Minford, Patrick, and Xiao, Zhiguo (2014) Banking and the macroeconomy in China: A banking crisis deferred?. Open Economies Review 25 (1), 123161.
Le Barbanchon, T. (2007) The Changing Response to Oil Price Shocks in France: A DSGE Type Approach. INSEE working paper no. g2007-07, Institut National de la Statistique et des Etudes Economiques.
Leduc, Sylvain and Sill, Keith (2004) A quantitative analysis of oil-price shocks, systematic monetary policy, and economic downturns. Journal of Monetary Economics 51 (4), 781808.
Lee, Kiseok and Ni, Shawn (2002) On the dynamic effect of oil price shocks: A study using industry level data. Journal of Monetary Economics 49 (4), 823852.
Levin, Andrew T., Wieland, Volker, and Williams, John (1999). Robustness of simple monetary policy rules under model uncertainty. In Monetary Policy Rules, pp. 263318. Chicago: University of Chicago Press.
Li, Chen, Ma, Wentao, and Wang, Bin (2010) Inflation expectation, the selection of monetary policy instruments and economy stability. China Economic Quarterly 1, 5182 (in Chinese).
Li, Wenbo and Li, Xin (2010) Interest-rate smoothing and the fluctuation of output and price: A framework of Taylor rule. Nankai Economic Studies 1, 3650 (in Chinese).
Liu, Bin (2008) Development of DSGE model in China and its application in the analysis of monetary policy. Journal of Financial Research 10, 121 (in Chinese).
Liu, Ming and Song, Xiao (2013) The effects of oil price shocks on China's macro-economy: A DSGE approach. Nankai Economic Studies 3, 7496 (in Chinese).
Lv, Chaofeng and Huang, Meibo (2012) International trade, international interest, and China's real economic cycle. Management World 3, 3449 (in Chinese).
Miao, Jianjun and Peng, Tao (2011) Business Cycles and Macroeconomic Policy in China: Evidence From an Estimated DSGE Model. Manuscript, Boston University.
Mishkin, Frederic S. (2007a) Headline Versus Core Inflation in the Conduct of Monetary Policy. Speech, Board of Governors of the Federal Reserve, October 20.
Mishkin, Frederic S. (2007b) Inflation dynamics. International Finance 10 (3), 317334.
Montoro, Carlos (2012) Oil shocks and optimal monetary policy. Macroeconomic Dynamics 16 (02), 240277.
Nakov, Anton and Pescatori, Andrea (2010) Monetary policy trade-offs with a dominant oil producer. Journal of Money, Credit, and Banking 42 (1), 132.
Neumann, Manfred JM and von Hagen, Jürgen (2002) Does inflation targeting matter? Center for European integration studies.
Rotemberg, Julio J. and Woodford, Michael (1996) Imperfect competition and the effects of energy price increases on economic activity. Journal of Money, Credit and Banking 28 (4), 549577.
Sbordone, Argia M. (2000) An optimizing model of U.S. wage and price dynamics. Manuscript, Rutgers University.
Schmitt-Grohé, Stephanie and Uribe, Martin (2005) Optimal Inflation Stabilization in a Medium-Scale Macroeconomic Model. NBER working paper no. 11854.
Siviero, Stefano and Veronese, Giovanni (2011) A policy-sensible benchmark core inflation measure. Oxford Economic Papers 63 (4), 648672.
Smets, Frank and Wouters, Raf (2003) An estimated dynamic stochastic general equilibrium model of the Euro area. Journal of European Economic Association 1 (5), 11231175.
Smets, Frank and Wouters, Raf (2007) Shocks and frictions in U.S. business cycles: A Bayesian DSGE approach. American Economic Review 97 (3), 586606.
Tang, Yunshu and Jiao, Jianlin (2012) Oil price shocks, monetary policy and adjustment and output volatility: Empirical evidence from China. Economic Theory and Business Management 7, 1727 (in Chinese).
Villa, Stefania (2016) Financial frictions in Euro area and the United States: A Bayesian assessment. Macroeconomic Dynamics 20 (05), 13131340.
Wang, Yunqing and Zhu, Qigui (2015) Energy price shocks, monetary policy and China's economic fluctuations. Asian-Pacific Economic Literature 29 (1), 126141.
Wang, Yunqing, Zhu, Qigui, and Tan, Zhengda (2013) Research on the fluctuations of housing market in China, based on DSGE of a two-sector model using Bayesian method. Journal of Financial Research 3, 101113 (in Chinese).
Xie, Ping and Luo, Xiong (2002) Taylor rule and its empirical test in China's monetary policy. Economic Research Journal 3, 312 (in Chinese).
Yang, Zhihui (2008) The effects of fiscal and monetary policy on private investment: An application of directed acyclic graphs. Economic Research Journal 5, 8193 (in Chinese).
Zhang, Bin and Xu, Jianwei (2010) Between oil price shocks and China's macro-economy: Mechanism, impact, and countermeasures. Management World 11, 1827 (in Chinese).
Zhang, Wenlang (2009) China's monetary policy: Quantity versus price rules. Journal of Macroeconomics 31 (3), 473484.
Recommend this journal

Email your librarian or administrator to recommend adding this journal to your organisation's collection.

Macroeconomic Dynamics
  • ISSN: 1365-1005
  • EISSN: 1469-8056
  • URL: /core/journals/macroeconomic-dynamics
Please enter your name
Please enter a valid email address
Who would you like to send this to? *



Full text views

Total number of HTML views: 0
Total number of PDF views: 30 *
Loading metrics...

Abstract views

Total abstract views: 202 *
Loading metrics...

* Views captured on Cambridge Core between 17th July 2017 - 23rd March 2018. This data will be updated every 24 hours.