Oil Shocks and Optimal Monetary Policy

This paper investigates how monetary policy should react to oil shocks in a microfounded model with staggered price-setting and oil as a non-produced input in the production function. We extend Benigno and Woodford (2005) to obtain a second order approximation to the expected utility of the representative household when the steady state is distorted and the economy is hit by oil price shocks. *Accepted in the Journal of Macroeconomic Dynamics.*