March 18, 2015

News Shocks in Open Economies: Evidence from Giant Oil Discoveries

From the The Grumpy Economist:

I attended the NBER EFG (economic fluctuations and growth) meeting a few weeks ago, and saw a very nice paper by Rabah Arezki, Valerie Ramey, and Liugang Sheng, "News Shocks in Open Economies: Evidence from Giant Oil Discoveries" (There were a lot of nice papers, but this one is more bloggable.)

They look at what happens to economies that discover they have a lot of oil.

An oil discovery is a well identified "news shock."

Standard productivity shocks are a bit nebulous, and alter two things at once: they give greater productivity and hence incentive to work today and also news about more income in the future.

An oil discovery is well publicized. It incentivizes a small investment in oil drilling, but mostly is pure news of an income flow in the future. It does not affect overall labor productivity or other changes to preferences or technology.

Rabah,Valerie, and Liugang then construct a straightforward macro model of such an event.

Utility comes from consumption and work. The production function has an oil sector and non-oil sector. There are adjustment costs to investment and to reallocation of capital between oil and non-oil sectors. The consumption good is tradeable, and the economy sells oil internationally to get it as well as to produce it.

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