Oil Shocks and Macroeconomic Adjustment: a DSGE modeling approach for the Case of Libya, 1970â 2007

Abstract

Libya experienced a substantial increase in oil revenue as a result of increased oil prices during the period of the late 1970s and early 1980s, and again after 2000. Recent increases in oil production and the price of oil, and their positive and negative macroeconomic impacts upon key macroeconomic variables, are of considerable contemporary importance to an oil dependent economy such as that of Libya. In this paper a dynamic macroeconomic model is developed for Libya to evaluate the effects of additional oil revenue, arising from positive oil production and oil price shocks, upon key macroeconomic variables, including the real exchange rate. It takes into consideration the impact of oil revenue upon the non-oil trade balance, foreign asset stock, physical capital stock, human capital stock, imported capital stock and non-oil production. Model simulation results indicate that additional oil revenue brings about: an increase in government revenue, increased government spending in the domestic economy, increased foreign asset stocks, increased output and wages in the non oil sector. However, increased oil revenue may also produce adverse consequences, particularly upon the non-oil trade balance, arising from a loss of competitiveness of non-oil tradable goods induced by an appreciation of the real exchange rate and increased imports stimulated by increased real income. Model simulation results also suggest that investment stimulating policy measures by government produce the most substantive benefits for the economy. JEL Classification: E27, E60, Q33, Q43, Q48.