Notes on the Underground: Monetary Policy in Resource-Rich Economies

The central bank of a commodity-exporting small open economy faces the traditional trade-off between domestic inflation and output gap. The commodity sector introduces a terms-of-trade inefficiency that gives rise to an endogenous cost-push shock, changes the target level for output, reduces the slope of the Phillips curve, and increases the importance of stabilizing the output gap. Optimal monetary policy calls for a reduction of the interest rate following a drop in the oil price. In contrast, a central bank with a mandate to stabilize consumer price inflation raises interest rates to limit the inflationary impact of an exchange rate depreciation.