External Shocks and Business Cycles in Nigeria: Accounting for the Roles of Domestic Oil-Refining Alternative and Oil Price Fiscal Rule

Abstract

The paper investigates the role of oil price fiscal rule (OPFR), and functional domestic oil refineries in curtailing the effects of external shocks on the Nigerian economy. A dynamic stochastic general equilibrium (DSGE) model is developed, calibrated and estimated using Random Walk Metropolis sampling method. The model is estimated under the benchmark, OPFR-only, and refinery-only scenarios. The results reveal that building or revamping domestic oil refineries may help the economy to withstand long term shock, but in the short run, the OPFR clearly emerges as the most potent. The non-oil external shocks are not significant under the three scenarios. However, oil-related external shocks have significant implications for business cycles in Nigeria, reinforcing the demand- and supply-side shocks. Furthermore, it is found that there is a need for functional domestic oil refineries in insulating the economy against external shocks, however, there is a huge welfare loss associated with refinery development alone. Thus, policymakers should consider instituting the OPFR to stem external shocks in the short run, while building oil refineries to tackle external shocks in the long run.