Question

most IKeiy the C. Paul Krugman, Nobel Prize winner and NYT writer, noted the following about the falling price of oil: When oil prices began their big plunge, it was widely assumed that the eco- nomic effects would be positive were expansionary monetary policy is a lot of investment spending closely tied to oil prices small oil price declines may be expansionary through usual channels, but really big declines set in motion a process of forced deleveraging among producers that can be a significant drag on the world economy. . we used to believe that oil price declines they reduced inflation, freeing central banks to loosen but now becausel the rise of fracking means that there What is wrong with Krugman's working assumption that a price change leads to changes in economic activity?

Answer 1

Here Krugman assumes lower oil prices create lower inflation and hence centralbanks loosen monetary policy by adopting expansionary monetary policy and cutting interest rates.

However lower oil prices need not bring CPi inflation down as it might happen that Prices of other products not dependent on oil might also increase due to market forces and hence CPI rises leading to wrong assumptions of loosening of monetary policy by Central bank.