Oil price stabilization and global welfare

Abstract

Oil price stabilization polices are adopted extensively in developing countries. Some argue that developed economies, especially the US, may gain from these policies through trade. This paper studies this issue in a two-country model with dollar currency pricing. We find that the optimal level of oil price stabilization chosen by developing countries and its implications for global welfare depend critically on whether monetary policy can effectively respond to oil shocks. In an environment without monetary shocks, when optimal monetary policies are considered, there is no role for oil price stabilization in developing countries. However, to make the oil price stabilization policy redundant, optimal monetary policy is not necessary. Some non-optimal endogenous monetary policies satisfying certain conditions can also make the developing countries choose zero oil price stabilization. The results change when there are monetary shocks. Even with optimal monetary policies, the developing countries will choose a positive level of oil price stabilization. However, due to dollar currency pricing, the US actually loses from the stabilization policy. Our results are well supported by the quantitative analysis in a full-fledged dynamic stochastic general equilibrium model.