Michael Plante

The Long-Run Macroeconomic Impacts of Fuel Subsidies

Many developing and emerging market countries have subsidies on fuel products. Using a small open economy model with a non-traded sector I show how these subsidies impact the steady state levels of macroeconomic aggregates such as consumption, labor supply, and aggregate welfare. These subsidies can lead to crowding out of non-oil consumption, inefficient inter-sectoral allocations of labor, and other distortions in macroeconomic variables. Across steady states aggregate welfare is reduced by these subsidies. This result holds for a country with no oil production and for a net exporter of oil. The distortions in relative prices introduced by the subsidy create most of the welfare losses. How the subsidy is financed is of secondary importance. Aggregate welfare is significantly higher if the subsidies are replaced by lump-sum transfers of equal value.

Time-varying oil price volatility and macroeconomic aggregates

We illustrate the theoretical relation among output, consumption, investment, and oil price volatility in a real business cycle model. The model incorporates demand for oil by a firm, as an intermediate input, and by a household, used in conjunction with a durable good. We estimate a stochastic volatility process for the real price of oil over the period 1986-2011 and utilize the estimated process in a non-linear approximation of the model. For realistic calibrations, an increase in oil price volatility produces a temporary decrease in durable spending, while precautionary savings motives lead investment and real GDP to rise. Irreversible capital and durable investment decisions do not overturn this result.

How Should Monetary Policy Respond to Changes in the Relative Price of Oil? Considering Supply and Demand Shocks

This paper examines optimal monetary policy in a New Keynesian model where supply and demand shocks affect the price of oil. Optimal policy fully stabilizes core inflation when wages are flexible. The nominal rate rises (falls) in response to the demand (supply) shock. With sticky wages core inflation falls (rises) in response to the demand (supply) shock. Impulse response functions from a VAR estimated with post-1986 U.S. data show minimal movement in core inflation in response to both shocks. The federal funds rate rises (falls) in response to the demand (supply) shock, consistent with the predictions from the theoretical model for policy that stabilizes core inflation.

OPEC in the News: The Effect of OPEC on Oil Price Uncertainty

We use a novel approach to identify how OPEC-related events affect oil price uncertainty. We introduce a newspaper article count variable related to OPEC that rises in response to important OPEC meetings, as well as political upheaval and terrorist attacks in OPEC countries. The variable is embedded in a structural vector autoregression model that also contains a measure of oil price uncertainty, namely an option-implied volatility, and a measure of macroeconomic uncertainty. Positive innovations in the article count, which identify the occurrence of OPEC-related events, lead to persistent and statistically significant increases in oil price uncertainty. The article count shock explains about 25 percent of the variation in uncertainty about oil prices. OPEC-related events were particularly important from the late-1990s to the late 2000s. These events do not strongly impact macroeconomic uncertainty but macro uncertainty independently plays an important role in the evolution of oil price uncertainty.

The Long-Run Macroeconomic Impacts of Fuel Subsidies in an Oil-Importing Developing Country

Analytical and numerical results show how the presence of a subsidy on household and firm purchases of oil products distorts long-run macroeconomic aggregates in an oil-importing developing country. Beyond leading to over-consumption of oil products these subsidies also lead to increased labor supply, a distorted emphasis on producing traded goods, and higher real wages. The subsidy also impacts the relative price of non-traded goods, causing it to fall when the non-traded sector is more oil-intensive than the traded sector and vice-versa.

Exchange Rates, Oil Price Shocks, and Monetary Policy In an Economy with Traded and Non-Traded Goods

This paper examines monetary policy responses to oil price shocks in a small open economy that produces traded and non-traded goods. When only labor and oil are used in production and prices are sticky in the non-traded sector the behavior of inflation, the nominal exchange rate, and the relative price of the non-traded good depends crucially upon whether the ratio of the cost share of oil to the cost share of labor is higher for the traded or non-traded sector. If the ratio is smaller (higher) for the traded sector then a policy that fully stabilizes non-traded inflation causes the nominal exchange rate to appreciate (depreciate) and the relative price of the non-traded good to rise (fall) when there is a surprise rise in the price of oil. Similar results can hold for a policy that stabilizes CPI inflation. Under a policy that flexes the nominal exchange rate, non-traded inflation rises (falls) if the ratio is smaller (larger) for the traded sector. Analytical results show that a policy of fixing the exchange rate always produces a unique solution and that a policy of stabilizing non-traded inflation produces a unique solution so long as the nominal interest rate is raised more than one-for-one with rises in non-traded inflation. A policy that stabilizes CPI inflation, however, produces multiple equilibria for a wide range of calibrations of the policy rule.

The U.S. shale oil boom, the oil export ban, and the economy: A general equilibrium analysis

This paper examines the effects of the U.S. shale oil boom in a two-country DSGE model where countries produce crude oil, refined oil products, and a non-oil good. The model incorporates different types of crude oil that are imperfect substitutes for each other as inputs into the refining sector. The model is calibrated to match oil market and macroeconomic data for the U.S. and the rest of the world (ROW). We investigate the implications of a significant increase in U.S. light crude oil production similar to the shale oil boom. Consistent with the data, our model predicts that light oil prices decline, U.S. imports of light oil fall dramatically, and light oil crowds out the use of medium crude by U.S. refiners. In addition, fuel prices fall and U.S. GDP rises. We then use our model to examine the potential implications of the former U.S. crude oil export ban. The model predicts that the ban was a binding constraint in 2013 through 2015. We find that the distortions introduced by the policy are greatest in the refining sector. Light oil prices become artificially low in the U.S., and U.S. refineries produce inefficiently high amount of refined products, but the impact on refined product prices and GDP are negligible.

The Impact of Changing Energy Prices on the Texas Economy

Energy is fundamental to the Texas economy, although its importance has changed over time. This study examines the relationship between energy prices and the Texas economy. We model the relationship between energy prices and Texas state-level employment, local employment and output across time periods. We find that energy price shocks have varying impacts on employment and output in different periods. The effects of energy price shocks, which had declined since the first oil boom of the 1970s and early 1980s, have become greater in recent years as a result of the shale revolution.

Time-Varying Oil Price Volatility and Macroeconomic Aggregates

We illustrate the theoretical relation between output, consumption, investment, and oil price volatility in a real business cycle model. We estimate a stochastic volatility process for the real price of oil using the Particle filter and Bayesian methods over the period 1986-2011 and use the estimated process in an otherwise standard real business cycle model. A third order approximation of the model is used to investigate the effects of time-varying oil price volatility on macroeconomic aggregates. For realistic calibrations, an increase in volatility produces a temporary decrease in the spending of durable goods but counterfactual increases in investment spending and real GDP. The increases in investment and GDP, which are not in line with empirical evidence on the effects of increases in oil price volatility, are driven by precautionary savings motives. We demonstrate that the model is able to qualitatively match empirical evidence once multi sectors or irreversible investment decisions are introduced.

Fiscal and Monetary Policy Responses to Oil Price Shocks in Oil Importing Low Income Countries

This paper considers monetary and fiscal policy responses to oil price shocks in low income oil importing countries. I examine the dynamic properties and the welfare implications of a set of inflation targeting policies and a group of policies where the government provides a subsidy on household purchases of oil products and finances this subsidy through some combination of printing money and raising non-distortionary lump sum taxes. Even in the case where lump sum taxes finance the subsidy, it distorts household behavior in important ways leading to over consumption of oil products, increased trade deficits, and distortions to the labor supply. Resorting to the inflation tax to finance the subsidy leads to significant macroeconomic issues when exchange rates are flexible. The welfare gains from a policy that finances the subsidy through lump sum taxation are small compared to the policy with full pass through. For most calibrations the losses from financing the policy through the inflation tax are substantial. The welfare generated by the inflation targeting policies is close to the baseline policy with full pass through so long as the response to inflation is strong enough.