Monetary Policy in an Oil-Exporting Emerging Economy with Fuel Subsidies

Abstract

This paper develops a DSGE model for an emerging oil-exporting economy with a fuel subsidy regime to analyse the stabilising role of alternative monetary policy rules under different subsidy arrangements. The model is estimated via Bayesian methods using data for Nigeria from 2000Q2 to 2019Q4. This paper (i) estimates a domestic fuel pricing rule for an oil-exporting emerging economy of Nigeria with fuel subsidies, (ii) characterizes monetary policy behaviour under such an estimated fuel pricing rule, and (iii) evaluates the appropriateness of alternative monetary policy rules under different assumptions regarding the fuel subsidy regime. The results show that approximately 45 per cent of changes to the global oil price are transmitted to the retail price of fuel. Also, it was found that the behaviour of monetary policy in Nigeria has been characterised by the headline inflation monetary rule. However, the monetary authority is able to reduce policy loss by approximately 11 per cent if it targets core inflation rather than a measure of inflation that includes energy prices. Under a zero-subsidy regime, the core inflation monetary rule outperforms its competitors in achieving overall macroeconomic stability, provided the share of oil in total consumption is relatively low.