Policy Mix in An Oil Exporting Country: Effectiveness of Countercyclical Measures in Mitigating External Shocks

Gauging the impact of oil price variations on small, oil-exporting countries has been heavily investigated under the umbrella of monetary policy interventions, using a standard general equilibrium framework. For some countries, the monetary policy coordinates with fiscal policy to deliver a better response to external oil shocks in an attempt to make the economic activity resilient to external backlash. This paper investigates the policy mix effectiveness in a small open economy, namely Algeria, and its ability to mitigate a negative oil price shock, using a DSGE model that maps several frictions found in single-commodity economies as for a managed exchange rate regime, the existence of a foreign exchange market accessible to households and a sovereign wealth fund. Simulations show countercyclical fiscal measures (increase in government spending) coupled with monetary interventions have no expansionary effects on output, but still necessary to maintain a resilient economic activity especially for the non-oil sector. Under the sticky prices assumption, households tend to lower their investment and consumptions levels, in addition of using their foreign currency savings as buffer. This results in alleviating potential pressures on the supply side and preventing possible inflation spikes. Findings confirm the effectiveness of a monetary policy based on targeting export products, to better handle the negative terms of trade shock via a slight exchange rate depreciation. However, the fiscal dominance in the policy-mix leads to the accumulation of public debt, which might require fiscal consolidation during protracted periods of declining oil prices.