Macroeconomic Dynamics

Notes

A NOTE ON OIL DEPENDENCE AND ECONOMIC INSTABILITY

Luís Aguiar-Conrariaa1 c1 and Yi Wena2

a1 NIPE and Universidade do Minho

a2 Federal Reserve Bank of St. Louis

Abstract

We show that dependence on foreign energy can increase economic instability by raising the likelihood of equilibrium indeterminacy, hence making it easier for fluctuations driven by self-fulfilling expectations to occur. This is demonstrated in a standard neoclassical growth model. Calibration exercises, based on the estimated share of imported energy in production for several countries, show that the degree of reliance on foreign energy for many countries can easily make an otherwise determinate and stable economy indeterminate and unstable.

Keywords:

  • Indeterminacy;
  • Energy Imports;
  • Externalities;
  • Returns to Scale;
  • Sunspots;
  • Self-Fulfilling Expectations

Correspondence:

c1 Address correspondence to: Luís Aguiar-Conraria, Departamento de Economia, Universidade do Minho, Campus de Gualtar, Braga 4710, Portugal; e-mail: lfaguiar@eeg.uminho.pt.

Footnotes

This is a substantially shortened version of our working paper, “Oil Dependence and Economic Instability” (Federal Reserve Bank of St. Louis, 2006). We thank Karl Shell, Nicholas Kiefer, and an anonymous referee for comments. Luís Aguiar-Conraria acknowledges financial support from the Fundação para a Ciência e a Tecnologia, project “Oil Shocks and the Macroeconomy: Econometric Estimation, Economic Modeling and Policy Implications,” PTDC/ECO/64750/2006. The usual disclaimer applies.

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