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Monetary Policy in Oil-Producing Economies

  • Roman E. Romero

    (Princeton University)

Most oil-producing economies have a strong dependence on oil revenues for their conomic performance and stability. This paper develops a general equilibrium model f an oil-producing economy that takes into account a new transmission channel for oil rice shocks. This transmission channel can be described as an income e¤ect generated y oil revenues, and the model shows that its role is important to fully understand monetary policy in these economies. I ?rst present a static model that illustrates that tension is present in such economies when faced with increases in oil prices. This ension arises, on the one hand, from the contractionary e¤ects of higher oil prices and, n the other hand, from the income e¤ect generated by the increased oil revenues. I hen present and solve a dynamic model with price rigidities in a two-sector economy ith an oil sector. I ?nd that the Phillips curve includes a measure of oil income that responsible for additional in?ationary pressures. Impulse response functions show hat, in terms of consumption and in?ation stabilization, the economy responds better o a Taylor rule that reacts to both ?nal goods production and oil production than o a Taylor rule that reacts to ?nal goods production only, although in the former he 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 n?ation and output without trade-o¤ by reacting optimally to in?ation and the output gap. Additionally, among Taylor-type rules, a rule that reacts to consumption and not only to fi?nal goods production is welfare superior.

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Paper provided by Princeton University, Department of Economics, Industrial Relations Section. in its series Working Papers with number 1053.

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Date of creation: Jan 2008
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Handle: RePEc:pri:indrel:169romero
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