Financial rigidities and oil‐based business cycles

Abstract

AbstractThe structural model of this paper incorporates a heterogeneous financial sector and an oil fund into a micro‐founded new Keynesian framework. We take a novel approach in introducing an oil fund into the model. This approach features a rule‐based budget financing, linkages between the oil and financial sectors and a saving mechanism for future generations. The primary goal is to examine the role of financial and non‐financial rigidities in an oil‐exporting economy. We show that financial rigidities are key in propagating shocks across sectors by differentiating interest rates in the economy. In addition, the financial sector transfers shocks from one sector to another through its intermediary role. We find that the oil fund plays a key role in the stabilization/propagation of oil price fluctuations through the saving‐liquidity transfer channel used by the central bank. These channels connect and amplify business and financial cycles in oil‐exporting economies.