DP13108 Notes on the Underground: Monetary Policy in Resource-Rich Economies

Author(s): Andrea Ferrero, Martin Seneca
Publication Date: August 2018
Keyword(s): monetary policy, oil export, small open economy
JEL(s): E52, E58, Q30
Programme Areas: International Macroeconomics and Finance
Link to this Page: www.cepr.org/active/publications/discussion_papers/dp.php?dpno=13108

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.