June 2007 (Revised May 2010)

Oil Shocks and External Adjustment

Martin Bodenstein, Christopher J. Erceg, and Luca Guerrieri


In a two country DSGE model, a shock that raises the price of oil persistently, e.g. an oil supply shock, leads to a deterioration in the oil balance of an oil importing country, such as the United States. With a low oil price elasticity and incomplete financial markets, the increased transfers to the oil exporter are substantial and generate a powerful drag on wealth for the oil importer. This wealth effect is principally responsible for compressing consumption and investment, an exchange rate depreciation, and a surplus in the nonoil balance.

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Keywords: Oil-price shocks, trade, DSGE models

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Last Update: October 19, 2020