I shall provide a link to the paper and an excerpt from the introduction.
Oil Shocks and the Zero Bound on Nominal Interest Rates
A key finding of our analysis is that oil price shocks propagate differently when policy rates in the oil importing
country are at the zero lower bound. In particular, we show that the zero lower bound
constraint tends to diminish rather than amplify the fall in GDP that occurs in response to
higher oil prices in normal times when monetary policy is unconstrained by the zero lower
bound.
To understand this result, consider the effects of a shock that raises the demand for oil
by foreigners, pushing up the price of oil in the home, oil-importing country. When
monetary policy is unconstrained, this shock tends to push up inflation and reduce output in
the home country. When policy rates are at the zero lower bound, the higher inflation
induced by the shock can lead to lower real rates, stimulating the interest-sensitive sectors of
the economy, and offsetting the usual contractionary effects of the shock. In fact, if the
increase in oil prices occurs gradually, it can induce a persistent rise in inflation that might
even cause GDP to expand temporarily.
And now for the commentary, from the Zero Hedge blog
In a self-immolating exercise in reductio ad absurdum, this superficial reasoning has led the Fed right up against the so-called 'zero-bound" in nominal rates (one which a dedicated inflationist could, in any case, make a great deal less constraining if $1 trillion in excess bank reserves did not accrued positive interest). Ergo, the only way the Doves feel they can deliver more "stimulus" via lower real rates is (a) to force down yields at longer and longer maturities - and rational capital allocation and return on invested income, go hang! - or (b) to push up either the rate of price appreciation itself, or, at the least, expectations thereof. Nominal rates down and/or prices up = real rates down -> spending up is the alpha and omega of their plan.
This last has even been taken to the ludicrous extremes that an FRB discussion paper last month, entitled 'Oil shocks and the Zero Bound, purports to argue that while higher oil prices normally lower output by pushing up inflation, once under conditions of ZIRP, the higher oil price raises inflation expectations, reduces the prospective real interest rate, and therefore stimulates the interest-rate sensitive parts of the economy!!!!
Oh, Brave New World! Here we are supposed to concur in the notion that a man whose job is at risk because his employer can no longer afford the dearer diesel he needs to run the factory, and whose commute to that work has suddenly become that much more expensive, too, will be inspired both by this heightened anxiety for his livelihood, as well as by his shrunken disposable cash flow, to take out a loan - which he would otherwise never have countenanced contracting - in order to buy a newly-built house at his lower real yield!!!!
Additionally, in this Bread from Stones scenario, we are supposed to imagine that an erstwhile despairing entrepreneur gets out of bed one morning and cries, "Hallelujah! The cost of coffee is up, cotton prices are surging, copper wire has just become exorbitant - I better go start a business before it's too late!"
In confounding cause with effect, in sacrificing the micro to the macro, in falling victim to any number of category errors and logical non sequiturs; in pursuing, with unthinking mathematical rigour, a set of utterly unreasonable premises to the point of an untenable - indeed, a highly damaging-conclusion, we have a prime example of everything that is wrong in mainstream economics and a glaring illumination of why the state interference which this typically seeks to justify has proven so counter-productive to this-or, indeed, to any other recovery of the past 80 years.
Perniciously, Mssrs Bodenstein, Guerrieri, and Gust even argue that the increasing material scarcity of an oil "shock" can be even more effective at dissolving the 'zero-bound'-and so-err-lessening the general material scarcity being suffered in the slump- if the price rise progresses at such a steady pace that people expect it to continue for some fairly protracted period and if the monetary authority now makes it unequivocally clear that it will not respond to this rise in its habitual manner.
In other words, this strongly insinuates that the Bernanke Fed actually welcomes the current surge in the prices of many of the staples of everyday life; that it actually exults in the drain being exerted on family budgets; that it revels in the squeeze on profit margins being suffered by already-struggling small businesses, because it imagines this will serve to lower the reckoning of the ethereal construct of a generalized, future real real interest rate and that this alone will serve to shower riches upon all who are presently suffering, in comparison for the present woes.
Pushing this line of argument up to the hilt, it also leads to the idea that the Fed-having already stretched credulity by consulting the less than disinterested counsel of the primary dealers regarding the size of its next assault on the free market-should also start buying baskets of commodities! Truly, that way madness lies-the madness of Wallace and Warren and Roosevelt's depression-prolonging circus of restrictionist and inflationist cranks.
