Business cycles in an oil economy

BIS Working Papers No 618
March 2017

Paper produced as part of the BIS Consultative Council for the Americas Research Network project "The commodity cycle: macroeconomic and financial stability implications"

The recent oil price fall has created concern among policy makers regarding the consequences of terms of trade shocks for resource-rich countries. This concern is not a minor one - the world's commodity exporters combined are responsible for 15-20% of global value added. We develop and estimate a two-country New Keynesian model in order to quantify the importance of oil price shocks for Norway - a large, prototype petroleum exporter. Domestic supply chains link mainland (nonoil) Norway to the off-shore oil industry, while fiscal authorities accumulate income in a sovereign wealth fund. Oil prices and the international business cycle are jointly determined abroad. These features allow us to disentangle the structural sources of oil price fluctuations, and how they affect mainland Norway. The estimated model provides three key results. First, oil price movements represent an important source of macroeconomic volatility in mainland Norway. Second, while no two shocks cause the same dynamics, conventional trade channels make an economically less significant difference for the transmission of global shocks to the oil exporter than to oil importers. Third, the domestic oil industry's supply chain is an important transmission mechanism for oil price movements, while the prevailing fiscal regime provides substantial protection against external shocks.

JEL classification: C11, E30, F41, F44

Keywords: DSGE, small open economy, oil and macro, Bayesian estimation