Exchange Rate Economics: Theories and Evidence

120 The sticky-price monetary model
the UK and Norway and the discovery of natural gas in the Netherlands – the
so-called Dutch disease – but is equally applicable to similar discoveries in other
countries. In a standard neoclassical model the discovery of oil would present no
special macroeconomic problems since wage and price flexibility ensures that an
oil discovery only leads to a change in relative prices: domestic output does not
deviate from its steady-state natural rate (see,for example,Minford 1977). But
in the Keynesian tradition of short-run price stickiness there may be important
short-run consequences of an oil discovery and the SPMA model should be useful
in illustrating this. The SPMA model has been utilised for this purpose by, inter alia,
Buiter and Miller (1981a),Eastwood and Venables (1982),Buiter and Purvis (1983)
and Sheffrin and Russell (1984). In analysing the effect of a resource discovery in
the SPMA model we follow Sheffrin and Russell (1984) and modify the model in
the following way.
In particular,we rewrite our money demand and aggregate demand schedules,
respectively,as:
and
m = α 0 p + (1 − α 0 )s + α 1 y − α 2 i + α 3ˆx; 0 0 (5.22)
d = β 1 (s − p) + α 4 x α 4 < 0 (5.23)
where the deflator for real money balances is now a weighted average of the price
of domestic output, p,and the price of imports,given by s. The terms x and ˆx
are oil-related: the former represents the permanent income stream from oil and
the latter current income from oil. Notice that,for simplicity,in deriving (5.23)
we have set γ 0 , γ 2 and γ 3 equal to zero. The model’s steady-state solution may be
derived by setting ṗ and ṡ equal to zero in (5.7) and (5.13) and solving (5.22) and
(5.23) simultaneously with d and y equated and i set equal to i ∗ :
p = (1 − α 0)
β 1
(α 4 x − y) + α 2 i ∗ − α 1 y − α 3ˆx + m,(5.24)
s = −α 0
β 1
(α 4 x − y) + α 2 i ∗ − α 1 y − α 3ˆx + m. (5.25)
Consider now the phrase diagram representation of this version of the SPMA
model for no initial oil wealth. The model’s dynamics are again portrayed by two
equations: a ṗ and ṡ equation. Thus on substituting (5.7) in (5.22) and (5.23) in
(5.13) we obtain:
ṡ = 1 α 2
[α 0 p + (1 − α 0 )s + α 1 y − m]−i ∗ ,(5.26)
ṗ = π[β 1 (s − p) − y]. (5.27)
The phase diagram representation of these two equations is given in Figure 5.9.
From (5.27) it is clear that the locus of s and p satisfying ṗ = 0 will be a positively