Working Paper: CEPR ID: DP13108
Authors: Andrea Ferrero; Martin Seneca
Abstract: The central bank of a commodity-exporting small open economy faces the traditional stabilization tradeoff between domestic inflation and output gap. The commodity sector introduces a terms-of-trade inefficiency that gives rise to an endogenous cost-push shock, changes the target level for output, reduces the slope of the Phillips curve, and increases the importance of stabilizing the output gap. Optimal monetary policy calls for a reduction of the interest rate following a drop in the oil price. In contrast, a central bank with a mandate to stabilize consumer price inflation needs to raise interest rates to limit the inflationary impact of an exchange rate depreciation.
Keywords: small open economy; oil export; monetary policy
JEL Codes: E52; E58; Q30
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Oil price reduction (L71) | Negative output gap (E31) |
| Oil price reduction (L71) | Lower interest rates (E43) |
| Lower interest rates (E43) | Stimulated economy (E65) |
| Oil price reduction (L71) | Domestic goods demand decrease (D12) |
| Domestic goods demand decrease (D12) | Negative output gap (E31) |
| Oil price reduction (L71) | Inflationary pressures from currency depreciation (F31) |
| Inflationary pressures from currency depreciation (F31) | Interest rates increase (E43) |