11/10/2023 0 Comments Creating funds oil exporter countries![]() ![]() The effectiveness of central banks’ contribution toward stabilisation thus rests on the existence of a credible/sustainable fiscal anchor. Medium runįossil-fuel exporters tend to overspend in good times leading to excessive indebtedness and crisis in bad times. If inflation expectations are not well-anchored because of limited central bank credibility and if the share of imported goods in the consumption basket is large, a tightening of monetary policy in the face of a negative terms-of-trade shock may be warranted. If inflation expectations are anchored, the central bank can afford to also worry about output stabilisation – that is, it can loosen monetary policy in a context of a negative terms-of-trade shock. In the case of a currency float, the central bank should set an inflation target. In the short run then, a peg allows fossil fuel countries to stabilise imported inflation and build credibility if the country maintains fiscal discipline to avoid a pervasive current account deficit. In practice, most countries loosen monetary policy when oil prices fall, suggesting that output stabilisation is more important than targeting inflation. While that rule would stabilise government oil revenue in local currency, it has no clear welfare rationale. Some authors have argued for setting the exchange rate to the domestic currency price of commodity exports. Some research has also shown that headline rather than core inflation targeting is more appropriate in the presence of credit constraints and when food represents a large share of the consumption basket. Flexible inflation targeting is constrained efficient. In the context of so-called commodity openness – both consumption and production – there appears to be no divine coincidence under standard assumptions. In a closed economy, the so-called divine coincidence – the equivalence between targeting inflation and output stabilisation – holds under the assumption of limited frictions (Blanchard and Gali 2007). In theory, the new Keynesian framework – with its incorporation of rigidity in wages and goods prices – offers guidance on the correspondence between targeting inflation and targeting output. But a central bank focused on stabilising output would loosen monetary policy because an oil price drop would lead to lower demand from the oil sector, increasing the output gap of the non-oil economy. For a central bank pursuing a strict inflation mandate, monetary policy should be tightened if oil prices fall – because a drop in prices would lead to an exchange rate depreciation that would cause prices to rise. Short runĪ dilemma for fossil fuel exporters is that there are two opposite views of the appropriate response of independent monetary policy to a drop in oil prices. (2018), I specifically examine the role monetary policy should play at different horizons – the short term, the medium term and the long term. Considering the degree of wealth concentration, the strong complementarity between fiscal and monetary policies, and the emergence of new risks to fossil fuel assets, there is a need to rethink monetary policy in fossil fuel exporters. ![]() Traditionally, the monetary policy horizon has been limited to that of the business cycle – typically two to six years. The high degree of concentration of wealth around fossil fuel assets makes it easy to argue for a monetary policy that looks beyond the business cycle horizon.įigure 1 Brent oil price (US dollars per barrel) But for fossil fuel exporters, risks are undeniably large. While the overall exposure to fossil fuels in advanced economies such as the UK or EU may appear relatively small, the systemic risk that could result from stranded assets should not be underestimated – after all, the Global Crisis was triggered by developments in the small subprime mortgage market in the US. That transition away from fossil fuels as a source of energy threatens the financial health of corporations, insurers, and other financial corporations that are exposed to fossil fuel assets. Part of the argument for central bank concern about climate change is the risk of financial instability from natural disasters and from the move away from fossil fuels, which would ultimately turn reserves of oil, natural gas, and coal into stranded assets. Five years later, ECB President Christine Lagarde said that she would move the bank beyond its traditional remit of controlling inflation to include tackling climate change. In a 2015 speech, Mark Carney, the then Governor of the Bank of England, sparked a debate over whether monetary policy should look beyond the horizon of the business and credit cycles to ensure financial stability in light of the risks posed by climate change (Carney 2015). ![]()
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