Oil Price. Increase in n Two-Sector Dependent Economy Model

This paper investigates the effects of a permanent increase in oil price on the accumulation of capital stock and the current account responses using a dynamic version of the two-sector dependent economy model developed by Brock and Turnovsky(1994), and Turnovsky and Sen(1995). For this purpose, oil, an imported intermediate input, is put into both sectors as a production factor. Then, we perform both long run steady state analysis and short run transitional dynamics in response to the unexpected rise in oil price. In the long run analysis, the value of capital stock at a new steady state is higher and thus current account deteriorates by making use of the negative relationship between capital stock and foreign traded bond. In addition, the consumption of two goods shows unclear responses even though they move in the same direction. The short run transitional dynamics is, however, too simple due to the constancy of the relative price of nontraded good at its steady state value; the relative price of nontraded good jumps up or down, but capital stock accumulates along the adjustment path, and thus the foreign traded bond (evolution of current account) moves in the opposite direction. This implies the current account may deteriorate during the adjustment period.