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Optimal macroeconomic stabilization policy of food, metal, and energy price cycles in small open economies

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Abstract

This paper proposes an optimal strategy for stabilizing macroeconomic policy to address jointly the effects of changes in the prices of food, minerals and energy (oil). Our approach differs from the general literature, which analyzes the effects of a commodity boom and therefore the solutions in terms of economic policy separately, that is, by type of commodity. The stabilization strategy that we propose considers a key fact affecting many small open economies, namely, that they not only are affected by increases in commodity prices, but also benefit from them. Consequently, we use a DSGE model for a small open economy with restricted households to show that welfare could be improved with a fiscal rule incorporating transfers to stabilize household consumption. This strategy noticeably dominates an aggressive monetary policy focused only on stabilizing inflation and a fiscal policy that has an excessive bias toward saving income from exports.

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Paper provided by Ilades-Georgetown University, Universidad Alberto Hurtado/School of Economics and Bussines in its series ILADES-Georgetown University Working Papers with number inv284.

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Length: 47 pages
Date of creation: Oct 2012
Date of revision:
Handle: RePEc:ila:ilades:inv284

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Keywords: commodity price boom; optimal fiscal and monetary policy; DSGE models;

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  1. Talvi, Ernesto & Vegh, Carlos A., 2005. "Tax base variability and procyclical fiscal policy in developing countries," Journal of Development Economics, Elsevier, vol. 78(1), pages 156-190, October.
  2. James P Walsh, 2011. "Reconsidering the Role of Food Prices in Inflation," IMF Working Papers 11/71, International Monetary Fund.
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