Dynamic Effects of Oil Price Shocks and Their Impact on the Current Account

Abstract

Our objective is to study the dynamic effects of an oil price shock on economic key variables and on the current account of a small open economy. To do this, we introduce time non-separable preferences in a standard model of a small open economy, where labor supply is endogenous and imported oil is used both as an intermediate input in production and as a consumption good. Using a plausible calibration of the model, we show that the changes in output and employment are quite small, and that the current account exhibits the J-curve property, both being in line with recent empirical evidence. After an oil price increase, the current account first deteriorates, and after some time it turns into surplus. We explain this non-monotonic behavior with agents' reluctance to change their consumption expenditures, resulting in an initial trade balance deficit which causes the current account to deteriorate.Over time, with gradually falling expenditures, the trade balance improves sufficiently to turn the current account into surplus. The model thus provides a plausible explanation of recent empirical findings.

Oil price shocks and the dynamics of current account balances in Nigeria

“…Other studies by Gruber and Kamin (2007) and Cooper (2008) found that current account deficits and imports would have been reduced by a significant amount if imported oil were relatively stable. Similarly, Schubert (2009) investigated the effects of oil price shocks on internal and external economic performance of a small open economy with particular focus on permanent increases in oil price. The findings were that after an oil price increase, the current account exhibited the J‐curve property by first deteriorating for a while and then improving.…”

Is an Intertemporal Model of the Current Account Valid for East Asian Countries? Evidence From Structural Var

“…Against previous results, current account surplus of Chinese in Hoffmann (2013) was driven by global shocks. Schubert (2014) investigated dynamic effects of oil price shocks and their impact on the current account. Narayan (2013) employ a structural VAR model to explore the similar issue.…”

Oil Dependence, International Borrowings, and Economic Instability in a Small Open Economy

“…27 In this circumstance, in addition to the four parameters used in Figure 2 (γ = 0, ρ = 0.01, α n = 0.7, and δ = 0.025), the following parameters are added. First, in line with Schubert (2014), the initial international oil price is normalized to p = 1. Second, we consider Korea as the representative small open economy with net oil imports.…”

“…One common feature of these studies is that their analysis is based on ad hoc behavioral specifications, and hence lacks a solid micro-foundation. The sharp rise in oil prices in the first half of 2008 led to a renewal of interest by macroeconomists in the harmful consequences arising from oil price shocks; see, e.g., Wen (2008, 2012), Blanchard and Riggi (2009), Kilian and Lewis (2011), Kormilitsina (2011), Schubert and Turnovsky (2011), Natal (2012), and Schubert (2014). Within the literature, some studies [e.g., Blanchard and Riggi (2009) and Kilian and Lewis (2011)] found that, compared with the two oil crises in the 1970s, the detrimental effect of rising oil prices in the 2000s was relatively mild.…”