The Small Oil Producer in the World Economy A Marco Model

Abstract

This paper models the macro-effects of exogenous oil and other shock on a small open economy (SOE) which is, itself, an oil producer. The model differs from existing literature in three major respects. First, the SOE has bot an oil sector and a manufacturing sector, where oil is used as an intermediate input. Second, the world economy in which the SOE is imbedded is explicitly modelled. It contains two additional nations: a large, dominantfirm- type oil monopolist, OPEC; and a large manufacturer, the rest-of-theworld (ROW), who uses imported oil as an intermediate input. Domestic and foreign manufactures are imperfect substitutes. Third, the SOE's authorities may, as in Canada, prevent world oil prices from being passed through to the domestic economy. Conventionally, the model is short-run while the world is characterized by flexible exchange rates, perfect financial capital mobility and rational expectations. The paper then analyzes the effects of various domestic and foreign shocks on the SOE's real GNP, consumer price index, and the composition of these two magnitudes. Of particular interest is the insulation properties, if any, of indexing domestic to world oil prices.