Dynamic Effects of Oil Price Shocks and their Impact on the Current Account

Schubert, Stefan Franz (2009): Dynamic Effects of Oil Price Shocks and their Impact on the Current Account. Published in: Macroeconomic Dynamics , Vol. 18, (2014): pp. 316-337.

Abstract

Our objective is to study the dynamic effects of an oil price shock on economic key variables and on the current account of a small open economy. To do this, we introduce time non-separable preferences in a standard model of a small open economy, where labor supply is endogenous and imported oil is used both as an intermediate input in production and as a consumption good. Using a plausible calibration of the model, we show that the changes in output and employment are quite small, and that the current account exhibits the J-curve property, both being in line with recent empirical evidence. After an oil price increase, the current account first deteriorates, and after some time it turns into surplus. We explain this non-monotonic behavior with agents' reluctance to change their consumption expenditures, resulting in an initial trade balance deficit which causes the current account to deteriorate. Over time, with gradually falling expenditures, the trade balance improves sufficiently to turn the current account into surplus. The model thus provides a plausible explanation of recent empirical findings.

• Item Type: MPRA Paper
• Language: English
• Keywords: oil price shocks; time non-separable preferences; current account dynamics
• Subjects: F - International Economics > F3 - International Finance > F32 - Current Account Adjustment ; Short-Term Capital Movements; F - International Economics > F4 - Macroeconomic Aspects of International Trade and Finance > F41 - Open Economy Macroeconomics; Q - Agricultural and Natural Resource Economics ; Environmental and Ecological Economics > Q4 - Energy > Q43 - Energy and the Macroeconomy

References

Agmon, T., Laffer, A. B., 1978. Trade, payments and adjustment: The case of the oil price rise. Kyklos 31, 68 - 85.

Alvarez-Cuadrado, F., Monteiro, G., Turnovsky, S. J., 2004. Habit formation, catching up with the joneses, and economic growth. Journal of Economic Growth 9, 47 - 80.

Asche, F., Gjolberg, O., Volker, T., 2003. Price relationships in the petroleum market: An analysis of crude oil and re¯ned product prices. Energy Economics 25, 289 - 301.

Auerbach, A., Kotlikoff, L., 1987. Dynamic Fiscal Policy. Cambridge University Press, New York.

Barro, R. J., Sala-i-Martin, X., 2003. Economic Growth, 2nd Edition. MIT Press, Cambridge Mass.

Barsky, R. B., Kilian, L., 2004. Oil and the macroeconomy since the 1970s. Journal of Economic Perspectives 18 (4), 115 - 134.

Bean, C. R., 1986. The terms of trade, labour supply and the current account. Economic Journal 96, 38 - 46.

Bhandari, J. S., Turnovsky, S. J., 1984. Material price increases and aggregate adjustment in an open economy - a stochastic approach. European Economic Review 25, 151 - 182.

Blanchard, O. J., Gali, J., August 2007. The macroeconomic effects of oil price shocks: Why are the 2000s so different from the 1970s? Working paper.

Bruno, M., Sachs, J. D., 1982a. Energy and resource allocation: A dynamic model of the dutch desease. Review of Economic Studies 49, 845 - 859.

Bruno, M., Sachs, J. D., 1982b. Input price shocks and the slowdown in economic growth: The case of uk manufacturing. Review of Economic Studies 49, 679 - 705.

Cardi, O., 2007. Another view of the j-curve. Macroeconomic Dynamics 11, 153 - 174.

Carroll, C. D., Overland, J., Weil, D. N., December 1997. Comparison utility in a growth model. Journal of Economic Growth 2, 339 - 367.

Carroll, C. D., Overland, J., Weil, D. N., June 2000. Saving and growth with habit formation. The American Economic Review 90 (3), 341 - 355.

Carroll, C. D., Slacalek, J., Sommer, M., March 2008. International evidence on sticky consump- tion growth. ECB Working Paper Series No 886.

Chatterjee, S., Turnovsky, S. J., 2006. Foreign aid and economic growth: The role of flexible labor supply. Journal of Development Economics Article in Press.

Corden, W. M., 1975. A Framework for Analyzing the Implications of the Rise in Oil Prices. Holmes and Meier, New York.

Dhawan, R., Jeske, K., 2006. How resilient is the modern economy to energy price shocks? Economic Review, Federal Reserve Bank of Atlanta (Third Quarter), 21 - 32.

Di Bartolomeo, G., Rossi, L., Tancioni, M., December 2005. Monetary policy under rule-of- thumb consumers and extenal habits: An international empirical comparison. Working Paper.

Edenhofer, O., Bauer, N., Kriegler, E., 2005. The impact of technological change on climate protection and welfare: Insights from the model mind. Ecological Economics 54, 277 - 292.

Eicher, T. S., Turnovsky, S. J., 1999. Convergence in a two-sector nonscale growth model. Journal of Economic Growth 4, 413 - 428.

Eicher, T. S., Turnovsky, S. J., 2001. Transitional dynamics in a two-sector non-scale growth model. Journal of Economic Dynamics and Control 25, 85 - 113.

Findlay, R. E., Rodriguez, C. A., 1977. Intermediate imports and macroeconomic policy under flexible exchange rates. Canadian Journal of Economics 10, 208 - 217.

Fuhrer, J. C., 2000. Habit formation in consumption and its implications for monetary-policy models. The American Economic Review 90 (3), 367 - 390.

Golub, S. S., 1983. Oil prices and exchange rates. The Economic Journal 93, 576 - 593.

Gruber, J. W., 2004. A present value test of habits and the current account. Journal of Monetary Economics 51, 1495 - 1507.

Gruber, J. W., Kamin, S. B., 2007. Explaining the global pattern of current account imbalances. Journal of International Money and Finance 26, 500 - 522.

Harberger, A. C., 1950. Currency depreciation, income, and the balance of trade. Journal of Political Economy 58, 47 - 60.

Hayashi, F., 1982. Tobin's marginal q and average q: A neoclassical interpretation. Econometrica 50, 213 - 224.

Huang, K. X. D., Meng, Q., 2007. The harberger-laursen-metzler effect under capital market imperfections. Journal of International Money and Finance 26, 1001 - 1015.

Ikeda, S., 2001. Weakly non-separable preferences and the harberger-laursen-metzler effect. Canadian Journal of Economics 34, 290 - 307.

Jimenez-Rodriguez, R., Sanchez, M., May 2004. Oil price shocks and real gdp growth - empirical evidence for some oecd countries. ECB Working Paper Series, No. 362.

Karayalcin, C., 2003. Habit formation and government spending in a small open economy. Macroeconomic Dynamics 7, 407 - 423. Kemfert, C., 1998. Estimated substitution elasticities of a nested ces production function ap- proach for germany. Energy Economics 20, 249 - 264.

Kilian, L., March 2007. A comparison of the effects of exogenous oil supply shocks on output and inflation in the g7 countries. Working Paper.

Kilian, L., Rebucci, A., Spatafora, N., 2007. Oil shocks and external balances. IMF Working Paper WP/07/110.

Krugman, P., 1983. Oil and the dollar. In: Bhandari, J. S., Putnam, B. H. (Eds.), Economic Interdependence and Flexible Exchange Rates. MIT Press, Cambridge, Mass.

Laursen, S., Metzler, L. A., 1950. Flexible exchange rates and the theory of employment. The Review of Economics and Statistics 32, 281 - 299.

Marion, N. P., 1984. Nontraded goods, oil price increases and the current account. Journal of International Economics 16, 29 - 44.

Marion, N. P., Svensson, L. E. O., 1984. Adjustments te expected and unexpected oil price changes. The Canadian Journal of Economics 15, 15 - 31.

McCallum, B. T., Nelson, E., 1999. Nominal income targeting in an open-economy optimizing model. Journal of Monetary Economics 43, 553 - 578.

Nordhaus, W., September 2007. Who's afraid of a big bad oil shock? Discussion Paper Prepared for Brookings Panel on Economic Activity, Special Anniversary Edition.

Obstfeld, M., 1980. Intermediate imports, the terms of trade and the dynamics of the current account. Journal of International Economics 10, 461 - 480.

Obstfeld, M., 1982. Aggregate spending and the terms of trade: Is there a laursen-metzler effect? Quarterly Journal of Economics 97, 251 - 270.

OECD, 2004. Oil price developments: Drivers, economic consequences and pol- icy responses. In: OECD (Ed.), OECD Economic Outlook No. 76. URL: http://www.oecd.org/dataoecd/19/6/34080955.pdf, accessed on Nov. 11, 2007, Ch. 9, pp. 1 - 29.

Ortigueira, S., Santos, M. S., 1997. On the speed of convergence in endogenous growth models. American Economic Review 87, 383 - 399.

Otto, G., 2003. Terms of trade shocks and the balance of trade: there is a harberger-laursen- metzler effect. Journal of International Money and Finance 22, 155 - 184.

Parry, I. W. H., Darmstadter, J., November 2004. The costs of us oil dependency. Paper prepared for the National Commission on Energy Policy.

Persson, T., Svensson, L. E. O., 1985. Current account dynamics and the terms of trade: Harberger-laursen-metzler two generations later. Journal of Political Economy 93, 43 - 65.

Rebucci, A., Spatafora, N., April 2006. Oil prices and global imbalances. In: IMF World Eco- nomic Outlook. IMF, Ch. 2, pp. 71 - 96.

Ryder, H. E., Heal, G. M., 1973. Optimal growth with intertemporally dependent preferences. Review of Economic Studies 40, 1 - 31.

Sachs, J., 1983. Theoretical issues in international borrowing. NBER Working Papers No. 1189.

Sachs, J., Cooper, R. N., Fischer, S., 1981. The current account and macroeconomic adjustment in the 1970s. Brookings Papers on Economic Activity 1, 201 - 268.

Schmidt, T., Zimmermann, T., 2005. Effects of oil price shocks on german business cycles. RWI : Discussion Papers No. 31.

Schmidt, T., Zimmermann, T., September 2007. Why are the effects of recent oil price shocks so small? Ruhr Economic Papers No. 29.

Sen, P., 1991. Imported input price and the current account in an optimizing model without capital mobility. Journal of Economic Dynamics and Control 15, 91 - 101.

Sen, P., Turnovsky, S. J., 1989. Deterioriation of the terms of trade and capital accumulation: A re-examination of the laursen-metzler effect. Journal of International Economics 26, 227 - 250.

Sommer, M., 2007. Habit formation and aggregate consumption dynamics. The B. E. Journal of Macroeconomics 7 (1 (Advances)).

Svensson, L. E. O., 1984. Oil prices, welfare and the trade balance. The Quarterly Journal of Economics 99, 649 - 672.

Svensson, L. E. O., Razin, A., 1983. The terms of trade and the current account: The harberger- laursen-metzler effect. Journal of Political Economy 91, 97 - 125.

Turnovsky, S. J., 1997. International Macroeconomic Dynamics. MIT Press, Cambridge, Mas- sachusetts.

Turnovsky, S. J., 2002. Knife-edge conditions and the macrodynamics of small open economies. Macroeconomic Dynamics 6, 307 - 335.

Turnovsky, S. J., October 2004. The transitional dynamics of fiscal policy: Long-run capital accumulation and growth. Journal of Money, Credit, and Banking 36 (5), 883 - 910.

Turnovsky, S. J., Sen, P., 1991. Fiscal policy, capital accumulation, and debt in an open economy. Oxford Economic Papers 43, 1 - 24.

Van der Werf, E., 2007. Production functions for climate policy modeling: An empirical analysis. Fondazione Eni Enrico Mattei, Working Paper 47.2007.

Willman, A., August 2003. Consumption, habit persistence, imperfect information and the life- time budget constraint. ECB Working Paper No. 251.