The Short-run Impact of Oil Windfalls in Low-income Countries: A DSGE Approach

Abstract

We use a multi-sector dynamic stochastic general equilibrium (DSGE) model—calibrated to the Ghanaian economy—to analyse the short-term impact of oil windfalls in low-income countries (LICs) and the role of various fiscal and monetary policy responses. The model includes limited access to international capital markets, limited participation by residents in the domestic financial system and limited labour mobility across sectors, features that are pervasive in these countries. Relative to developed countries, oil windfalls are likely to have larger aggregate demand pressures. A policy of fiscal smoothing—associated with a sovereign wealth fund—can help achieve macroeconomic stability and improve welfare. On the other hand, accumulation of reserves in response to the windfall— without fiscal backing—can crowd out the private sector and reduce welfare. These findings highlight the importance of policy coordination for the macroeconomic effects of oil proceeds in LICs.