Exchange rate fluctuations, oil price shocks and economic growth in a small net-importing economy

Abstract

Policy makers often rely on theoretical wisdom and tend to allocate huge resources towards hedging strategies against oil price and exchange rate movements without considering to first test these theories on a context basis. To overcome this limitation, we model both upward and downward movements in oil prices and exchange rates in order to study the oil – exchange rate – growth nexus for a small net-importing country like Liberia. We estimate an unrestricted VAR model and document the following results: First, a rise in the price of oil appears to stimulate Liberian GDP. Second, depreciation in the value of the Liberian dollar causes real GDP to fall while appreciation of the Liberian dollar tends to have no impact on real GDP in Liberia. Third, trade balance has a positive correlation with growth of the Liberian economy. Finally, consumer prices are found to also correlate positively with economic growth in Liberia. Contrary to bulk of the literature, this paper provides general insights that a rise in oil price is sometimes good for net-oil importers.