We assess the impact of oil shocks on euro-area (EA) macroeconomic variables by estimating with Bayesian methods a two-country New Keynesian model of EA and rest of the world (RW). Oil price is determined according to supply and demand conditions in the world oil market. We obtain the following results. First, a 10% increase in the international price of oil generates an increase of about 0.1 annualized percentage points in EA consumer price inflation. Second, the same increase in the oil price generates a decrease in EA gross domestic product (GDP) of around 0.1% and a trade deficit, if it is due to negative oil supply or positive oil-specific demand shocks. Third, it generates a mild EA GDP increase and a trade surplus if due to a positive RW aggregate demand shock. Fourth, the increase in the oil price over the 2004–2008 period did not induce stagflationary effects on the EA economy because it was associated with positive RW aggregate demand shocks. The drop in RW aggregate demand contributes to explain the 2008 fall in oil prices, EA GDP and inflation.
