Oil Shocks and External Adjustment

56 Pages Posted: 26 Jul 2007

See all articles by Martin Bodenstein

Martin Bodenstein

Board of Governors of the Federal Reserve System

Christopher J. Erceg

Board of Governors of the Federal Reserve System

Luca Guerrieri

Federal Reserve Board - Trade and Financial Studies

Date Written: June 2007

Abstract

This paper investigates how oil price shocks affect the trade balance and terms of trade in a two country DSGE model. We show that the response of the external sector depends critically on the structure of financial market risk-sharing. Under incomplete markets, higher oil prices reduce the relative wealth of an oil-importing country, and induce its nonoil terms of trade to deteriorate, and its nonoil trade balance to improve. The magnitude of the nonoil terms of trade response hinges on structural parameters that affect the divergence in wealth effects across oil importers and exporters, including the elasticity of substitution between oil and other inputs in production, and the discount factor. By contrast, cross-country wealth differences effectively disappear under complete markets, with the implication that oil shocks have essentially no effect on the nonoil terms of trade or the nonoil trade balance.

Keywords: Oil-price shocks, trade, DSGE models

JEL Classification: F32, F41

Suggested Citation

Bodenstein, Martin and Erceg, Christopher J. and Guerrieri, Luca, Oil Shocks and External Adjustment (June 2007). FRB International Finance Discussion Paper No. 897. Available at SSRN: https://ssrn.com/abstract=1003167 or http://dx.doi.org/10.2139/ssrn.1003167

Martin Bodenstein (Contact Author)

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

Christopher J. Erceg

Board of Governors of the Federal Reserve System ( email )

20th St. and Constitution Ave.
Washington, DC 20551
United States
202-452-2575 (Phone)
202-736-5638 (Fax)

Luca Guerrieri

Federal Reserve Board - Trade and Financial Studies ( email )

20th St. and Constitution Ave.
Washington, DC 20551
United States
202-452-2550 (Phone)

Register to save articles to
your library

Register

Paper statistics

Downloads
160
rank
181,029
Abstract Views
897
PlumX Metrics