Monetary Policy and the Dutch Disease in a Small Open Oil Exporting Economy

Abstract:     
In this paper, we compare, first, the impact of a windfall and a boom sectors on the economy of an oil exporting country and their welfare implications; in a second step, we analyze how monetary policy should be conducted to insulate the economy from the main impact of these shocks, namely the Dutch Disease. To do so, we built a Multisector DSGE model with nominal and real rigidities. The main finding is that Dutch disease effect arise after spending and resource movement effects in the following cases: flexible prices and wages both in the case of a windfall and in the case of a boom; flexible wage and sticky price only in the case of a fixed exchange rate. In other cases, Dutch disease effect can be avoided if: prices are sticky and wages are flexible when the exchange rate is flexible; prices and wages are sticky whatever the objective of the central bank is in both cases: windfall and boom. We also compare the source of fluctuation that leads to Dutch disease effect and we conclude that the windfall leads to a strong effect in terms of de-industrialization compared to a boom. The choice of flexible exchange rate regime also helps to improve welfare.

Number of Pages in PDF File: 41

Keywords: monetary policy, Dutch disease, oil prices, small open economy

JEL Classification: E52, F41, Q40

working papers series