Optimal exchange rate policy for a small oil-exporting country: A dynamic general equilibrium perspective

• Published in: Economic modelling 2014-01, Vol.36, p.88-98
• Main Author: Abri, Almukhtar Saif Al
• Format: Article
• Language: English
• Subjects: Consumers; Decision making models; Economic theory; Exchange rate regimes; Exchange rates; Exports; Foreign exchange rates; General economic equilibrium; Keynesian theory; New Keynesian Small Open Economy model; Oil industry; Oil supply; Oil-exporting countries; Open economies; Petroleum industry; Primary-commodity economy; Studies; Welfare analysis
• ISSN: 0264-9993; 1873-6122
• DOI: 10.1016/j.econmod.2013.09.016

This paper examines the choice of optimal exchange rate regime for an oil-exporting small open economy using a welfare-based model. The paper extends the standard New Keynesian Small Open Economy model to include three countries: a small oil-exporting country and two large foreign countries. The model also features three sectors: traded, non-traded, and primary-commodity (crude-oil). The sources of uncertainty are random monetary (demand), productivity (real), and real oil price (supply) shocks. Despite the absence of a non-oil traded sector in this primary-commodity economy, the welfare analysis suggests that flexible exchange rate regimes can reduce external shocks and consumption volatility given certain caveats about pricing-schemes. The analysis also suggests that a basket peg is more welfare-improving than a unilateral peg, as higher volatility of the anchor currency reduces consumer welfare. •Examines the optimal exchange rate regime for a small oil-exporting economy•Develops a three-country New Keynesian Small Open Economy model•Welfare analysis is based on the level and the variance of consumption per capita.•Flexible exchange regimes reduce the impact of shocks on home consumption.•A basket peg is more welfare-improving than a unilateral peg.