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Fiscal and Monetary Policy Responses to Oil Price Shocks in Oil Importing Low Income Countries

Michael Plante

Indiana University Economics Department

August 14, 2009

CAEPR Working Paper No. 017-2009

This paper considers monetary and fiscal policy responses to oil price shocks in low income oil importing countries. I examine the dynamic properties and the welfare implications of a set of inflation targeting policies and a group of policies where the government provides a subsidy on household purchases of oil products and finances this subsidy through some combination of printing money and raising non-distortionary lump sum taxes. Even in the case where lump sum taxes finance the subsidy, it distorts household behavior in important ways leading to over consumption of oil products, increased trade deficits, and distortions to the labor supply. Resorting to the inflation tax to finance the subsidy leads to significant macroeconomic issues when exchange rates are flexible. The welfare gains from a policy that finances the subsidy through lump sum taxation are small compared to the policy with full pass through. For most calibrations the losses from financing the policy through the inflation tax are substantial. The welfare generated by the inflation targeting policies is close to the baseline policy with full pass through so long as the response to inflation is strong enough.

Number of Pages in PDF File: 55

Keywords: oil prices, monetary and fiscal policy, durables, low income countries

JEL Classification: O23, E52, Q43, F41

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Date posted: August 19, 2009  

Suggested Citation

Plante, Michael, Fiscal and Monetary Policy Responses to Oil Price Shocks in Oil Importing Low Income Countries (August 14, 2009). CAEPR Working Paper No. 017-2009. Available at SSRN: http://ssrn.com/abstract=1456398 or http://dx.doi.org/10.2139/ssrn.1456398

Contact Information

Michael Plante (Contact Author)
Indiana University Economics Department ( email )
Wylie Hall
Bloomington, IN 47405-6620
United States
812-855-8580 (Phone)
812-855-3736 (Fax)
HOME PAGE: http://mypage.iu.edu/~mplante

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