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Monetary Policy in Oil-Producing Economies

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  • Roman E. Romero

    (Princeton University)

Abstract

Most oil-producing economies have a strong dependence on oil revenues for their economic performance and stability. This paper develops a general equilibrium model of an oil-producing economy that takes into account a new transmission channel for oil price shocks. This transmission channel can be described as an income effect generated by oil revenues, and the model shows that its role is important to fully understand monetary policy in these economies. I first present a static model that illustrates that a tension is present in such economies when faced with increases in oil prices. This tension arises, on the one hand, from the contractionary effects of higher oil prices and, on the other hand, from the income effect generated by the increased oil revenues. I then present and solve a dynamic model with price rigidities in a two-sector economy with an oil sector. I find that the Phillips curve includes a measure of oil income that is responsible for additional inflationary pressures. Impulse response functions show that, in terms of consumption and inflation stabilization, the economy responds better to a Taylor rule that reacts to both final goods production and oil production than to a Taylor rule that reacts to final goods production only, although in the former the volatility implied for non-oil output is higher. I also explore welfare-based optimal monetary policy in this framework and conclude that a central bank can stabilize both inflation and output without trade-o§ by reacting optimally to inflation and the output gap. Additionally, among Taylor-type rules, a rule that reacts to consumption and not only to final goods production is welfare superior.

Suggested Citation

  • Roman E. Romero, 2008. "Monetary Policy in Oil-Producing Economies," Working Papers 1053, Princeton University, Department of Economics, Center for Economic Policy Studies..
  • Handle: RePEc:pri:cepsud:169romero.pdf
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    References listed on IDEAS

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    Cited by:

    1. Andrea Ferrero & Martin Seneca, 2019. "Notes on the Underground: Monetary Policy in Resource‐Rich Economies," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 51(4), pages 953-976, June.
    2. Joab Dan VALDIVIA CORIA & Daney David VALDIVIA CORIA, 2017. "Impulse on the Aggregate Demand in Bolivia through the Coordination of the Monetary and Fiscal Policy in Crisis Time," Journal of Economics Bibliography, KSP Journals, vol. 4(2), pages 156-173, June.
    3. Samuel Wills, 2014. "Optimal Monetary Responses to Oil Discoveries," CAMA Working Papers 2014-37, Centre for Applied Macroeconomic Analysis, Crawford School of Public Policy, The Australian National University.
    4. Drechsel, Thomas & McLeay, Michael & Tenreyro, Silvana, 2019. "Monetary policy for commodity booms and busts," CEPR Discussion Papers 14030, C.E.P.R. Discussion Papers.
    5. Samuel Wills, 2012. "Optimal Monetary Responses to Oil Discoveries," Discussion Papers 1408, Centre for Macroeconomics (CFM), revised Apr 2014.
    6. Omotosho, Babatunde S., 2019. "Business Cycle Fluctuations in Nigeria: Some Insights from an Estimated DSGE Model," MPRA Paper 98351, University Library of Munich, Germany.
    7. Mohsen Mohammadi Khyareh & Vahid Taghinejad Omran & Mohammad Ali Ehsani, 2015. "Evaluating The Welfare Aspects Of The Simple Monetary Rules For Iran," Economic Annals, Faculty of Economics, University of Belgrade, vol. 60(206), pages 141-166, July - Se.

    More about this item

    Keywords

    monetary policy;

    JEL classification:

    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • O23 - Economic Development, Innovation, Technological Change, and Growth - - Development Planning and Policy - - - Fiscal and Monetary Policy in Development

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