The impact of oil price shocks in the Canadian economy: A structural investigation on an oil-exporting economy

Abstract

Oil price shocks and monetary policy response by oil producing economies have been the subject of important theoretical investigation in the modern literature. This topic seems to be well grounded since fluctuations in the US dollar, which is affected by US monetary policy, plays an important role in exacerbating run ups and precipitous falls in world oil prices. We investigate the economic consequences of oil price shocks using an open-economy DSGE model that incorporates demand for and supply of oil while allowing for interaction between domestic and foreign monetary policy. Using Canadian and U.S. data, we quantify the relative importance of oil price shocks and monetary policy response on macroeconomic variables. We show that domestic monetary policy is a key channel that accounts for over 40% of discounted variation in domestic output across a 4-year horizon after an oil shock. In contrast, US monetary policy is of lesser importance in propagating oil price shocks on an oil-exporting economy through the international channel. • Dramatic changes in oil prices have led to speculation that US monetary policy has a significant influence on the Canadian economy. • Volatility in value of dollar has a major impact on world oil prices. • The economic consequences of oil price shocks are investigated using a DSGE model. • The domestic monetary policy is a key channel that account for over 40% of discounted variation in domestic output after an oil shock. • US monetary policy turns out to be of lessor importance in propagating the oil price shocks.