Optimal oil taxation in a small open economy

The international oil market has been very volatile over the past three decades. In industrialized economies, especially in Europe, taxes represent a large fraction of oil prices and governments do not seem to react to oil price shocks by using oil taxes strategically. The aim of this paper is to analyze optimal oil taxation in a dynamic stochastic general equilibrium model of a small open economy that imports oil. We find that in general it is not optimal to distort the oil price paid by firms with taxes, neither in the long run nor over the business cycle. The general result could be reversed depending on environmental considerations and available fiscal instruments. We provide simulations to illustrate the optimal response to shocks in such cases.     

Oil prices and economic downturns: the case of Spain

We address the macroeconomic effects of an oil price shock in Spain. We apply a vector autoregression model (VAR) analysis to quarterly data for the Spanish economy since 1986, to elucidate the effects of variations in the oil price on the economy, considering the three main causes of disruptions in the oil markets: oil supply shocks, oil demand shocks and oil-specific (precautionary) demand shocks. We conclude that the effects in Spain strongly depend on the type of shock: the consumer price index (CPI) has mainly been influenced by oil demand shocks; output has only reacted to oil supply shocks; and monetary policy has mainly reacted after precautionary shocks. Second-round effects caused by the behaviour of nominal wages have not been found. Additionally, we discuss two facts: the ability of firms to increase markups in a context of rising demand and the procyclical role of monetary policy when faced with oil demand shocks.     

Responses to World Oil and Coal Shocks, in a Short-Run Fuel Substitution Tax Model

This article examines effects on major Australian macroeconomic and structural variables of simultaneous shocks to world oil and black coal prices. The illustrative numerical results have been produced with the short-run fuel substitution tax model, ORANI-LFT. The current version of that model reflects the Australian Governmet's pre-1988 oil regulatory framework, and the simulations reported in this study reflect the recent switch from significant dependence on crude oil levy revenue to petroleum products excise revenue. Empirical results show that combined world oil and coal price shocks lead to substantially different effects than would occur from an oil shock alone. A major implication of this, for a small open economy such as Australia, is that particular attention has to be paid to the interdependence of world energy market, both when analysing the effects of such shocks and when formulating appropriate macroeconomic and energy policy responses. It is also pointed out how the model could be modified for investigating effects under deregulated oil market regimes.     

Should a central bank react to food inflation? Evidence from an estimated model for Chile

We examine whether food price shocks are a major source of macroeconomic fluctuations. We estimate a small open economy DSGE model using an alternative Taylor rule applied to Chilean data. The empirical evidence suggests that food inflation played a non-trivial role in shaping Chile's de facto monetary policy actions. Consistent with its commitment to price stability, the central bank increases the policy rate in reaction to food inflation. Despite an immediate monetary policy reaction to a food price shock, the policy rate gradually tapers off. This is due to a second-round effect on non-food inflation propagated by the food price shock. A main finding is that monetary policy that targets headline inflation is welfare improving.     

Price-level targeting rules and financial shocks: The case of Canada

How important are the benefits of low price-level uncertainty in the presence of financial shocks? This paper explores the desirability of price-level path targeting in a small open economy with credit frictions à la Bernanke et al. (1999). The model features credit flows and exogenous shocks that originated in both domestic and international credit markets. Financial shocks, exacerbating the distortion generated by the debt-deflation channel, provide a rational for an interest-rate response to the price-level. Indeed, a price-level targeting rule reduces the trade-off between the nominal debt distortion and the inefficiency generated by nominal price stickiness. The policy implications are based on social welfare evaluations. Parameter's uncertainty does not significantly affect the main results.     

HOW DO OIL PRICE SHOCKS AFFECT A SMALL NON‐OIL PRODUCING ECONOMY? EVIDENCE FROM HONG KONG

We find no evidence from either in‐sample or out‐of‐sample analyses that an oil price shock would necessarily affect a small non‐oil producing economy such as Hong Kong. In our in‐sample recursive vector autoregressive investigations, oil price does not Granger cause the key macroeconomic indicators. The forecast errors from our out‐of‐sample examination using a vector error correction model with oil shocks, which represents an extension to previous studies, were found to be statistically the same as those from the vector error correction model without these shocks. The analysis leads us to dispel the conventional wisdom that a small non‐oil producing economy is more vulnerable to oil shocks than a larger oil‐producing economy such as the USA.     

A structural VAR business cycle model for a volatile small open economy

New Zealand is a small economy exposed to a volatile climate, relatively volatile international trade prices, and its exposure to international financial markets has increased markedly since economic reforms in the 1980s. This paper applies identification techniques suggested by Cushman and Zha [Cushman, D.O. and Zha T.A., 1997. Identifying monetary policy in a small open economy under flexible exchange rates, Journal of Monetary Economics, 39, pp. 433–448.], Zha [Zha, T.A., (1999). Block recursion and structural vector autoregression, Journal of Econometrics, 90, pp. 291–316.] and Dungey and Pagan [Dungey, M. and Pagan, A., 2000. A structural VAR model of the Australian economy, The Economic Record, 76, pp. 321–342.] to develop a large four block structural VAR model of the New Zealand business cycle to capture these features. The model reveals that climate and international trade price shocks have been more important sources of business cycles fluctuations than international or domestic financial shocks. Furthermore, the model does not encounter the price and exchange rate puzzles that have bedevilled attempts to identify monetary policy shocks in small open economy SVAR models.     

Asymmetric responses of money demand to oil price shocks in Saudi Arabia: a non-linear ARDL approach

Saudi Arabia is an open oil-based economy with fixed exchange rates; therefore, it has limited monetary policy autonomy. Using non-linear autoregressive distributed lag approach, this article investigates the asymmetric effects of oil price shocks on the demand of money in Saudi Arabia over the period 1990:Q1–2014:Q4. The empirical results show evidence of positive long run but asymmetric effects of oil price shocks on the money demand. In particular, we find that the positive oil price shocks are more important than negative shocks. Therefore, two policy responses can be considered: either sustaining the fixed exchange rate regime and following an economic diversification policy or switching towards a flexible exchange rate regime to achieve price stability. In that case, the existence of a stable money demand function in Saudi Arabia is a necessary precondition for adopting a monetary policy strategy targeted to price stability using instruments like money targeting.     

Foreign Capital,Skill Formation,and Migration of Skilled Workers

We study the interaction between foreign capital inflow and international migration of skilled labor when a small open economy is subject to exogenous shocks. The presence of a skill formation sector is central to our analysis, such that import liberalization and increased foreign capital inflow may lead to increased skill emigration both in absolute terms and as percentage of gross skill formation. Furthermore, a positive product price shock for the sector that uses foreign capital may turn out to be immiserizing. Finally, growth in the agricultural sector can lower the rate of skill formation as well as skill emigration.     

Monetary policy and the transmission of oil shocks

This paper provides evidence on the role played by monetary policy in the transmission of oil shocks to the US economy. We show that for the period since 1986, oil shocks have had a negative effect on stock returns, regardless of whether the oil shock is defined as the percentage change in the price of oil or a nonlinear transformation of that series. We then demonstrate that there is no relationship between the reaction of individual stock prices to oil shocks and to monetary policy shocks. This implies that oil shocks do have effects on the economy beyond their effect on monetary policy. We conclude that systematic monetary policy is not as effective as suggested in some previous studies.     

Analysis of shock transmissions to a small open emerging economy using a SVARMA model

Using a parsimonious structural vector autoregressive moving average (SVARMA) model, we analyse the transmission of foreign and domestic shocks to a small open emerging economy under different policy regimes. Narrower confidence bands around the SVARMA responses compared to the SVAR responses, advocate the suitability of this framework for analysing the propagation of economic shocks over time. Malaysia is an interesting small open economy that has experienced an ongoing process of economic transition and development. The Malaysian government imposed exchange rate and capital control measures following the 1997 Asian financial crisis. Historical decomposition and variance decomposition allow contrast of shocks propagating under different policy regimes. Malaysia is highly exposed to foreign shocks, particularly under the managed float exchange rate system. During the pegged exchange rate period, Malaysian monetary policymakers experienced some breathing space to focus on maintaining price and output stability. In the post-pegged period, Malaysia's exposure to foreign shocks increased and in recent times are largely driven by world commodity price and global activity shocks.     

MONETARY AND FISCAL POLICY EFFICIENCY AND COORDINATION IN A MULTI‐SECTOR OPEN‐ECONOMY GENERAL EQUILIBRIUM MODEL

The paper analyzes monetary and fiscal stabilization and coordination in a multi‐sector stochastic new open economy macroeconomics (NOEM) model. It first aims to assess the capacity of fiscal and monetary policy to reduce or eliminate the negative welfare effects of an unanticipated productivity shock affecting some or all of the sectors in each country. Second, it evaluates the possible gains from international monetary cooperation as well as the impact of active fiscal policy on the welfare performance of monetary policy. The setup also allows for international asymmetry concerning the uncertainty over the shocks. The results show that monetary and fiscal policies are efficient tools of stabilization and under several conditions they can replicate the flexible‐price equilibrium. However, their welfare performance is not necessarily increased when both monetary and fiscal policies react to shocks at the national level. The existence of bilateral gains from monetary cooperation depends on the degree of asymmetry concerning the uncertainty over the shocks.     

Productivity Shocks and Monetary Policy in a Two-Country Model

In this paper, we examine the effects of foreign productivity shocks on monetary policy in a symmetric open economy. Our two-country model incorporates the New Keynesian features of price stickiness and monopolistic competition based on the cost channel of Ravenna and Walsh (2006). In particular, in response to asymmetric productivity shocks, firms in one country achieve a more efficient level of production than those in another economy. Because the terms of trade are directly affected by changes in both economies’ output levels, international trade creates a transmission channel for inflation dynamics in which a deflationary spiral in foreign producer prices reduces domestic output. When there is a decline in economic activity, the monetary authority should react to this adverse situation by lowering the key interest rate. The impulse response function from the model shows that a productivity shock can cause a real depreciation of the exchange rate when economies are closely integrated through international trade.     

The Exchange Rate and Inflation in the UK

The United Kingdom is a highly open economy, and has a monetary policy strategy of targeting inflation in consumer prices. In this paper, we look at the evidence from the UK on inflation behaviour, and examine the propositions from several theoretical models about inflation dynamics in an open economy, focusing in particular on the hypothesized connections between the exchange rate and consumer price inflation. Theoretical open‐economy macroeconomic models ‘cover the waterfront’ on this issue, ranging from ‘exchange rate disconnect’ to a rigid link between nominal exchange rate changes and inflation. We estimate on UK data the open‐economy Phillips curves implied by the alternative explanations. We argue that, of the alternatives considered, only a model where imports are modelled as an intermediate good, as in McCallum and Nelson (1999) , provides a reasonable match with the data. Unlike the standard model, in which imports are treated as a final consumer good, the intermediate‐goods specification provides support for a policy of CPI inflation targeting.     

A MODEL OF INFLATION TRANSMISSION IN AN EXCHANGE RATE TARGET ZONE

I incorporate an exchange rate target zone with intramarginal interventions in a small open economy model. Using the method of undetermined coefficients, I solve for the price level and the nominal exchange rate to determine how price shocks from the large economy affect the small open economy. The results show that the behaviour of inflation transmission within the band differs from the behavior of inflation transmission at the edge of the band of the target zone. Foreign shocks can affect local prices in both cases but the central bank can respond through market interventions within the band while it cannot do so at the edge. Near the edge of the band, a central bank has to intervene to stop the exchange rate from breaching the band. My model predicts that if the interventions are robust, then the exchange rate is mean reverting and an exchange rate target zone can insulate an economy from foreign price shocks. Based on the model, central bank interventions contribute to long‐run price stability in a target zone regime. Finally, I empirically test the model using unit root and cointegration tests, and present some policy implications.     

Supply shocks and the interdependence of macroeconomic stability under flexible exchange rates

This paper analyzes the effects of a change in the monetary policy of a large economy on the macroeconomic stability of a small open economy with high dependence on imported intermediate goods. The analysis is carried out using the Taylor framework where the money supply rule is specified by the degree of monetary accommodation of price shocks. A supply shock to the large country is transmitted as both demand and supply shocks to the small country. A shift toward less monetary accommodation by the large country is shown to increase both price and output instability in the small country through the supply side linkage, while it may enhance price or output stability through the demand side linkage. Simulation results for Germany and Japan suggest that the supply side effect on price stability is important and that the effect on output stability depends crucially on the importance of trade in goods between the large country and the country in question.     

Multipliers of expected vs. unexpected fiscal shocks: The case of Korea

We compare the multipliers of expected and unexpected fiscal shocks. In doing so, we consider that the future path of fiscal policy is anticipated to some degree, and incorporate this characteristic into a news approach. We build a standard small open economy New-Keynesian DSGE model with a fully specified fiscal policy structure, and examine the Korean economy as an example of a small open emerging economy. We find that the present-value multiplier of the government consumption news shock in Korea is smaller than that of a corresponding surprise shock of the same magnitude, apart from the initial couple of years in the case of the output multiplier, and is consistently smaller in the cases of the consumption and investment multipliers. The present-value output multiplier of the government consumption news shock starts from about 0.72 and declines continuously to reach 0.16 after 40 years.     

Euro area,oil and global shocks: An empirical model-based analysis

We assess the impact of oil shocks on euro-area (EA) macroeconomic variables by estimating with Bayesian methods a two-country New Keynesian model of EA and rest of the world (RW). Oil price is determined according to supply and demand conditions in the world oil market. We obtain the following results. First, a 10% increase in the international price of oil generates an increase of about 0.1 annualized percentage points in EA consumer price inflation. Second, the same increase in the oil price generates a decrease in EA gross domestic product (GDP) of around 0.1% and a trade deficit, if it is due to negative oil supply or positive oil-specific demand shocks. Third, it generates a mild EA GDP increase and a trade surplus if due to a positive RW aggregate demand shock. Fourth, the increase in the oil price over the 2004–2008 period did not induce stagflationary effects on the EA economy because it was associated with positive RW aggregate demand shocks. The drop in RW aggregate demand contributes to explain the 2008 fall in oil prices, EA GDP and inflation.     

Business cycle fluctuations in Taiwan — A Bayesian DSGE analysis

This paper examines the Taiwanese economy in a small open economy DSGE model using Bayesian estimation. The model consists of two countries and 12 exogenous shocks with stochastic volatility to capture the fluctuations in the business cycle. The main results are: (1) shock innovations with stochastic volatility increase the model fit, (2) shocks originated from outside the country are important sources of fluctuations in the Taiwanese business cycle.