Monetary Policy Rule, Exchange Rate Regime, and Fiscal Policy Cyclicality in a Developing Oil Economy

This paper constructs a dynamic stochastic general equilibrium model of joint monetary and fiscal policy for a developing oil economy to find an appropriate monetary rule combined with pro-/countercyclical and neutral fiscal stance based on a loss measure. The model captures a set of structural specifics: two monetary instruments–interest rate and foreign exchange interventions, two fiscal instruments–public consumption and public investment, two production sectors–oil and non-oil, and the two types of households–optimizers and rule-of-thumb households. It further includes a Sovereign Wealth Fund, the foreign debt of private sector via collateral constraint, and a world oil price shock. The loss measure is chosen as an equal summation of variances in in ation, output, and real exchange rate to be minimized by Taylor rule’s parameters in a small open economy. The foreign exchange interventions distinguish between managed and exible exchange rate regime. Fiscal policy cyclicality is referred to the oil output response of public consumption and public investment. Impulse response functions to the negative world oil price shock are analyzed at exible and rigid prices.