DP6700 Oil Price Movements and the Global Economy: A Model-Based Assessment

Author(s): Selim Elekdag, Rene Lalonde, Doug Laxton, Dirk Muir, Paolo Pesenti
Publication Date: February 2008
Keyword(s): DSGE models, Oil prices, World economy
JEL(s): E66, F32, F47
Programme Areas: International Macroeconomics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=6700

We develop a five-region version (Canada, a group of oil exporting countries, the United States, emerging Asia and Japan plus the euro area) of the Global Economy Model (GEM) encompassing production and trade of crude oil, and use it to study the international transmission mechanism of shocks that drive oil prices. In the presence of real adjustment costs that reduce the short- and medium-term responses of oil supply and demand, our simulations can account for large endogenous variations of oil prices with large effects on the terms of trade of oil-exporting versus oil-importing countries (in particular, emerging Asia), and result in significant wealth transfers between regions. This is especially true when we consider a sustained increase in productivity growth or a shift in production technology towards more capital- (and hence oil-) intensive goods in regions such as emerging Asia. In addition, we study the implications of higher taxes on gasoline that are used to reduce taxes on labour income, showing that such a policy could increase world productive capacity while being consistent with a reduction in oil consumption.