A short–run macroeconomic model is estimated for Venezuela to examine the hypothesis that the availability of oil resources may entail a “confidence effect”—on perceived future incomes—that influences the expenditure and portfolio behavior of economic agents. The confidence effect is found to he empirically significant. Model simulations reveal that the impact of oil price changes on the level and variability of money demand, the balance of payments, and inflation are significantly more pronounced when this effect is present, with important implications for the size and structure of the needed policy interventions. [JEL 121, 132]
The purpose of this paper is to examine the short-run macroeconomic implications of natural resource availability—as well as its exhaustibility—in the case of Venezuela. Although considerable attention has been paid in the economic literature to the manner in which the economies of oil producers such as Venezuela are influenced by variations in the flow of income generated by oil resources, the models used in the studies have in general ignored two important distinguishing characteristics of oil-based economies. The first relates to the possible “confidence effect” that resource availability might have on the behavior of economic agents. This effect has been highlighted by the studies of the “Dutch disease”—that is, the problem of deindustrialization attributable to a booming export sector (Buiter and Purvis (1983), Cordon and Neary (1982), Eastwood and Venables (1982), Neary and van Wijnbergen (1984), and van Wijnbergen (1984)). It arises from the impact of resource availability on future expected income, which can in turn influence saving behavior, the pattern of expenditure, and the composition of asset portfolios. The second important characteristic is the exhaustibility of oil resources. Although the economic literature is replete with studies of the implications of the exhaustibility of petroleum resources for optimal production and price strategies in petroleum-based economies, the short-run macroeconomic models of such economies have in general sidestepped the question of the depletability of the main source of income (Aghevli (1977), Aghevli and Sassanpour (1982), Khan (1976), and Knight and Mathieson (1980)). Although these models do recognize that the exhaustibility of oil has major implications from the point of view of economic management, in general they consider exhaustibility as a long-run concept with little or no consequences in the short run. The validity of such a position is questionable, however, because exhaustibility is likely to influence expectations about future income, thus inducing shifts in perceived wealth that may in turn affect private sector confidence and its behavior in the short run.
The analytical framework of this paper explicitly incorporates these key characteristics of major oil-based developing countries.1 The analysis suggests that, in the case of Venezuela, the impact of an oil-price shock on the economy becomes considerably more pronounced once these features are taken into account. In particular, such a disturbance would lead to significantly greater variations both in the balance of payments and in domestic prices than is suggested by earlier models that ignore these features of resource-based economies. Consequently, remedial policies adopted in the face of such disturbances would need to be greater in intensity and, sometimes, longer in duration than those suggested by previous studies.
The model is applied to the Venezuelan economy over the period 1965–81. The choice of country was dictated both by data availability and by a desire to preserve the general characteristics of the model as far as possible, thus to make it applicable to other oil-producing developing countries. Venezuela seems especially suitable for this purpose because it is a small and relatively liberal economy where the generality of the model specification could be preserved.
Moreover, during the sample period Venezuela maintained a free exchange system with no restriction on capital flows. Since early 1983, however, the Venezuelan exchange system has undergone major modifications, rendering it highly restrictive. In particular, a multiple exchange system has been introduced, and all private capital transactions are now channeled through the free exchange market and are subject to prior authorization. Choice of the period of study was based on these considerations.
The rest of the paper is organized as follows. The specification of the model is presented in Section I, followed in Section II by a discussion of the estimation results and their policy implications. Some simulation exercises are reported in Section III to highlight the impact of exogenous shocks on the economy, and the conclusions of the study are summarized in Section IV.
APPENDIX Data Sources and Simulation Results
All the data used in the study, except for those mentioned below, have been obtained from the International Monetary Fund’s International Financial Statistics (Washington, various issues).
The index of traded goods price (pt) was calculated as the weighted average of trading partners’ export prices, adjusted for the exchange rate. The countries and weights used were the following: United States (0.33), Netherlands Antilles (0.14), Canada (0.08), Japan (0.06), Italy (0.06), Brazil (0.04), Federal Republic of Germany (0.03), other (0.26).
The level of oil production (OP) and the stock of oil reserves (S) in 1982 were obtained from various issues of the Petroleum Economist (London). The stock of oil for other periods was obtained as
Domestic oil consumption (DOC) was obtained from various Fund reports on Venezuela.
The following variables were derived residually:
non-oil GDP, Y:
Y = GDP— oil exports—domestic consumption of oil (DOC);
private expenditures, E:
private capital inflows (net), PKI:
domestic government revenues, DR:
The dummy variable (D) was set equal to unity for 1980 and 1981 and equal to zero otherwise. Domestic and foreign interest rates were measured by the rate offered on one-year deposits in Venezuela and by the three-month U.S. Treasury bill rate, respectively.
Aghevli, Bijan B., “Money, Prices and the Balance of Payments: Indonesia, 1968–73,” Journal of Development Studies (London), Vol. 13 (January 1977), pp. 37–57.
Aghevli, Bijan B., and Cyrus Sassanpour, “Prices, Output and Trade Balance in Iran,” World Development (Oxford, England), Vol. 10 (September 1982), pp. 791–800.
Amuzegar, J. Jahangir, “Oil Exporters’ Economic Development in an Interdependent World,” Occasional Paper 18 (Washington: International Monetary Fund, April 1983).
Blejer, Mario, “The Short-Run Dynamics of Prices and the Balance of Payments,” American Economic Review (Nashville, Tennessee), Vol. 67 (June 1977), pp. 419–28.
Buiter, Willem H., and Douglas Purvis, “Oil, Disinflation, and Export Competitiveness” in Economic Interdependence and Flexible Exchange Rates, ed. by J. Bhandari and B. Putnam (Cambridge, Massachusetts: MIT Press, 1983).
Cordon, W. Max, and J.P. Neary, “Booming Sector and De-Industrialization in a Small Open Economy,” The Economic Journal (London), Vol. 92 (December 1982), pp. 825–48.
Davarajan, Shantayanan, and Anthony Fisher, “Hotelling’s ‘Economics of Exhaustible Resources’: Fifty Years Later,” Journal of Economic Literature (Nashville, Tennessee), Vol. 19 (March 1981), pp. 65–73.
Eastwood, R.K., and A.J. Venables, “The Macroeconomic Implications of a Resource Discovery in an Open Economy,” The Economic Journal (London), Vol. 92 (June 1982), pp. 285–99.
Friedman, Milton, “The Demand for Money: Some Theoretical and Empirical Results,” Journal of Political Economy (Chicago), Vol. 67 (1959), pp. 327–51.
Goldfeld, Stephen, Commercial Bank Behavior and Economic Activity: A Structural Study of Monetary Policy in the United States (Amsterdam: North Holland, 1966).
Hamburger, Michael J., “The Demand for Money in an Open Economy: Germany and the United Kingdom,” Journal of Monetary Economics (Amsterdam), Vol. 3 (January 1977), pp. 25–40.
Hotelling, Harold, “The Economics of Exhaustible Resources,” Journal of Political Economy (Chicago), Vol. 39 (April 1931), pp 137–75.
Khan, Mohsin S., “Experiments with a Monetary Model for the Venezuelan Economy,” Staff Papers. International Monetary Fund (Washington), Vol. 21 (July 1974), pp. 389–413.
Khan, Mohsin S., “A Monetary Model of Balance of Payments: The Case of Venezuela,” Journal of Monetary Economics (Amsterdam), Vol. 2 (July 1976), pp. 311–332.
Khatkhate, Deena R., W. van der Hoeven, and D.P. Villaneuva, “The Venezuelan Financial System and the Monetary Policy Instruments” (unpublished; Washington: International Monetary Fund, 1974).
Knight, Malcolm, and Donald J. Mathieson, “Economic Change and Policy Response in Canada Under Fixed and Flexible Exchange Rates” (unpublished; Washington: International Monetary Fund, 1980).
Lewis, Stephen Jr., “Development Problems of Mineral-Rich Countries” in Economic Structure and Performance, ed. by Syrquin, Taylor, and Westphal (Orlando, Academic Press, 1984).
McKenzie, G., and S.M. Schadler, “Exchange Rate Policies and Diversification in Oil-Exporting Countries” (unpublished; Washington: International Monetary Fund, 1980).
Neary, J.P., and S. van Wijnbergen, “Can an Oil Discovery Lead to a Recession? A Comment on Eastwood and Venables,” The Economic Journal (London), Vol. 94 (June 1984), pp. 390–95.
Sassanpour, Cyrus, “The Effects of Oil Revenues on the Indonesian Economy, 1969–83,” paper presented at the Atlantic Economic Society meetings (Washington, August 1985).
Sundararajan, V., “Exchange Rate Versus Credit Policy: Analysis with a Monetary Model of Trade and Inflation in India,” Journal of Development Economics (Amsterdam), Vol. 20 (January—February 1986), pp. 75–105.
Sundararajan, V., and Subhash Thakur, “Public Investment, Crowding Out, and Growth: A Dynamic Model Applied to India and Korea,” Staff Papers, International Monetary Fund (Washington), Vol. 27 (December 1980), pp. 814–55.
Van Wijnbergen, Sweder, “Inflation, Employment, and the Dutch Disease in Oil-Exporting Countries: A Short-Run Disequilibrium Analysis,” Quarterly Journal of Economics (New York), Vol. 99 (May 1984), pp. 233–50.
Mr. Vaez-Zadeh, Senior Economist in the Central Banking Department of the Fund, is a graduate of The Johns Hopkins University.
For a detailed discussion of other characteristics of oil-producing developing countries, see Amuzegar (1983).
Allowing for oil as an intermediate input may be tantamount to building an automatic Dutch disease process into the model, with the non-oil export sector being adversely affected whenever oil export prices increase. This procedure may, of course, be justified in some countries such as Canada. See Knight and Mathieson (1980).
A fall in the relative price of the crop induces a shift to other profitable crops, whereas in oil-exporting countries a switch to other exports that could adequately substitute for oil is clearly not feasible in the short run (see Lewis (1984)).
If the country is small, so that its import supply function is inelastic, and if domestic and foreign goods are perfect substitutes and no import restrictions exist, it makes no difference whether the government initially spends oil revenues on domestic or on foreign goods and services. Rather than influencing domestic prices, any excess liquidity created through government operations will initially leak out through imports. See McKenzie and Schadler (1980).
Because oil income accrues to the government, its impact on money demand (and other private demand variables) works indirectly through the government expenditure function. Thus, oil income has not been included as an independent variable in money demand and private expenditure equations.
Some studies (for example, Sundararajan and Thakur 1980) have postulated an increasing relationship between the speed of adjustment (u) and the availability of resources for private capital formation. The variable for availability, measured by the difference between aggregate savings and government investment, was not found to be a significant factor determining private investment in Venezuela.
The possibility that the divergence of relative prices from their long-run equilibrium value could also influence nontraded-goods prices was excluded from the price equation, since empirical tests showed that this divergence was not significant.
Non-oil exports accounted for no more than 5 percent of total exports in Venezuela during the sample period.
If assets are perfectly substitutable, net capital flows will be indeterminate, and the estimates obtained from this equation cannot be interpreted meaningfully.
It is assumed that government foreign receipts equal oil export receipts plus net foreign borrowing.
This difference between the two stocks can be viewed as the “flow” demand for real balances; see Sundararajan (1986)
The theory from which these decision rules are derived assumes, among other things, a monopolistic market structure, no binding technological constraints, and full information—none of which may hold in practice. In addition, the decision rules will be more complicated because the rate of return on financial assets may itself be affected by the variations in the price of oil. Given these considerations, the simplifying assumption in the text may be somewhat unrealistic.
This assumption can be justified on the grounds that, in a market economy, the most obvious indicator of time preference is the rate of interest. In other words, the interest rate is supposed to adjust until it simultaneously equates the rate of time preference of all individuals in the society and the rate of return on productive investment.
Oil revenues (OR) rise if the extraction rate or the price of oil increases. A resource discovery does not necessarily lead to either of these developments.
More precisely, the larger real balance gap will reduce the rate of change in nontraded-goods prices compared with what that rate would have been in the absence of a change in the real balance gap.
The ensuing feedback effects will be strengthened or weakened depending on whether private investment is stimulated or depressed by a rise in F; that is, whether u3 in equation (3) is positive or negative.
Although the starting point of the above discussion is the effect of a change in F, the subsequent argument could be applied to changes in any other variable of the model. Clearly, however, the sequence of events as well as the final outcome will vary according to the nature of the original change. The feedback effects of movements in money supply and capital flows fall on credit to the private sector. Although the exchange rate variable does not enter the model explicitly, the impact of changes in this variable can be analyzed in a similar way. Because a change in the exchange rate affects oil revenues and prices of traded goods instantaneously, its impact on endogenous variables is equivalent to the combined effect of changes in these variables.
This effect is absent from the previous empirical works on oil-exporting countries.
Data sources are given in the Appendix. The consumer price index P has been used as the deflator except in the case of imports, for which an index of traded goods prices—calculated from partner country data—has been used. A systems estimation method, such as full information maximum likelihood (FIML), would have been preferable for reducing the simultaneous equation bias and to ensure that the a priori restrictions on parameters were satisfied. Such method, however, could result in large specification errors, especially for small samples.
These results should be interpreted with caution because, for small samples, the properties of the probability distribution of coefficients estimated by the two-stage least-squares method are not well known. Goldfeld (1966) believes that this procedure tends to produce conservative t-statistics.
Adjustment over T periods is calculated as
A variable that does not appear to be significant in a particular equation could, however, be significant in the context of the model as a whole, and its omission could result in appreciable changes in other coefficients of the model.
The coefficients of yd and yt-1 (the variables that constitute the components of excess demand in the goods market) are significant at the 1 percent level in equation (4). The results for this equation, as well as for those for domestic inflation, are quite reasonable in view of the fact that these equations are estimated in the first-difference form: even if original errors are independent, negative correlation could he introduced in first-difference equations, rendering both the standard error of the coefficients and the
The estimated coefficients of gr and gt–1 add up to unity.
These results are in contrast to those obtained by Khan (1974), in which GDP growth in either country was not found to be a significant factor affecting capital movements in Venezuela.
Given the wide fluctuations in these flows, the extent of the variations explained by the capital flow equation (92 percent) is quite impressive. The results of this equation are superior to those obtained by Khan (1974), both in terms of the explanatory power of the equation and the significance of the variables. This superiority could be attributable in part to Khan’s use of the change in U.S, interest rates as an explanatory variable instead of interest rate differentials, as in the present study.
This procedure is called dynamic simulation. It provides a more rigorous test of model stability than static simulation because in static simulation actual values of the lagged endogenous variables are used, whereas in dynamic simulation errors can accumulate over time.
A price hike always affects expected oil wealth, even if the price hike is accompanied by an equivalent expansion in oil output. In the latter case, expected oil wealth decreases in the period when output grows but remains unchanged in the subsequent periods
Again, this is an unlikely scenario because it implies a temporary increase in S. It is examined here in an attempt to isolate the impact of oil wealth on the economy.
The charts for capital flows (Figure 8) and the balance of payments (Figure 9) record the time path of the absolute (rather than percentage) difference between the shock simulations and the base run. This is necessary because these variables can be positive or negative during the sample period.
GDP growth is an argument in the capital flows equation.
Because oil is the dominant component of GDP in Venezuela, GDP grows rapidly in the first period as oil revenues increase. The second period witnesses a decline in GDP (compared with the historical trend) as oil revenues are restored to their original level. Thereafter, GDP growth reflects only the increase in non-oil output because oil income remains unchanged.