Oil price shocks and monetary policy in resource-rich economies: Does capital matter?

Abstract

This paper studies monetary policy in a small open oil-exporting economy, focusing on the roles of (i) capital, and (ii) oil intensity of domestic production. It builds on the DSGE model of Ferrero and Seneca (JMCB 2019), extending it along features (i) and (ii) above. We find that a negative oil price shock contracts domestic output, lowers domestic inflation, depreciates the exchange rate, increases headline inflation, and elicits a monetary policy contraction. Notably, our results show that the introduction of capital into the model economy moderates the responses of output and inflation to an oil price shock. Also, allowing for oil intensity in the production of domestic goods attenuates the inflationary pressures arising from a negative oil price shock. Finally, we find that the two added features indeed matter for the monetary authority’s response to an oil price shock. Our findings highlight the need for cautious interpretation of the quantitative results emanating from DSGE models of oil-producing economies that abstract from these features. Monetary policy exercises conducted on the basis of such restricted models should also be interpreted with caution.