Abstract
This paper examines the macroeconomic effects of an adverse oil price shock under different exchange rate and fiscal policy arrangements in 40 oil-exporting countries from 1973 to 2010 using panel vector autoregression techniques. The results show that output and government consumption fall in response to an oil price decline. However, the output response is significantly smaller and smoother in countries with flexible exchange rate regimes due to a larger and immediate real exchange rate depreciation. There is also less need for contractionary fiscal policy as the real depreciation appears to play a sufficient dampening role. In contrast, countries with fixed exchange rate regimes experience a small and delayed real depreciation, leaving fiscal policy to bear the bulk of the macroeconomic adjustments costs. Nevertheless, the presence of oil funds in these countries is associated with smaller fiscal spending cuts and hence a reduced output fall. These findings highlight the shock-absorbing property of flexible exchange rates and the potential macroeconomic stabilisation role of oil funds in insulating against adverse oil price movements, making a case for oil exporters to adopt more flexible exchange rate regimes and establish oil funds as fiscal buffers.
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Notes
Russia had operated on a managed float since 1999 but transitioned to a free floating regime in November 2014, earlier than originally planned, partly as a result of the sharp fall in oil prices.
Timor-Leste and Turkmenistan also satisfy the criteria but are excluded as their exchange rate regimes are not properly classified as either fixed or flexible for the purposes of this paper; see Ilzetzki et al. (2010).
See Tavlas et al. (2008) for a summary of these approaches, and also references on other exchange rate classifications.
Oil funds with a stated savings objective usually also allow discretionary transfers to the budget to smooth expenditures during the down cycle. Most oil funds have dual objectives of savings and stabilisation.
According to Kilian (2009), oil price shocks have historically been driven mainly by global aggregate demand and precautionary demand shocks rather than oil supply shocks.
This is akin to assigning dummy variables for fixed and flexible regimes in the panel VAR specification.
Since the panel VAR estimation consists of only one lag, a t-test can be used to test the null hypothesis that the coefficients under fixed and flexible exchange rate regimes are the same. For two or more lags, a F-test or Wald test can be used to test the null hypothesis that the coefficients in all the lags are the same.
The policy trilemma in international economics posits that it is impossible to have fixed exchange rates, free capital mobility and independent monetary policy at the same time.
Recall that the proliferation of oil funds only began in the late 1990s.
Institutional quality data is taken from Kuncic (2014), using the average of legal, political and economic institutions. The data is from 1990 to 2010.
Money supply (M2) is used since interest rate data is not available for many of the oil-exporting countries. Interest rate is also not the core monetary policy instrument in most of these countries.
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Acknowledgments
I thank Warwick McKibbin, Renée Fry-McKibbin, Joshua Chan, Fabrizio Carmignani, Alrick Campbell and participants at the 11th Australasian Development Economics Workshop (ADEW), Singapore Economic Review Conference 2015, 28th PhD Conference in Economics and Business and the ANU Crawford PhD Conference 2015 for useful comments and feedback. I gratefully acknowledge funding from ADEW, ANU Vice Chancellor’s Travel Grant and ANU Crawford School of Public Policy to present this paper at the conferences. I also thank Inessa Love and Ryan Decker for sharing their codes. I am also indebted to an anonymous referee for valuable suggestions to improve the manuscript.
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This research is supported by the Centre for Strategic and Policy Studies (CSPS), Brunei Darussalam, where I am employed as an Associate Researcher. I declare that there are no other relevant or material financial interests that relate to the research described in this paper.
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Koh, W.C. Oil price shocks and macroeconomic adjustments in oil-exporting countries. Int Econ Econ Policy 14, 187–210 (2017). https://doi.org/10.1007/s10368-015-0333-z
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DOI: https://doi.org/10.1007/s10368-015-0333-z