Oil Related Shocks and Macroeconomic Adjustment under Different Nominal Exchange Rate Policy: The Case of the Libyan Economy

This paper analyses the dynamic macroeconomic adjustment processes arising from oil production rehabilitation for a small open economy such as that of Libya, operating under different nominal exchange rate regimes with different degrees of capital mobility. The paper utilises a general dynamic macroeconomic framework to identify whether adverse Dutch disease consequences arising from oil production recovery upon the non-oil trade balance could be alleviated by adopting an alternative nominal exchange rate policy. The model utilised in this paper is likely to be of interest to other oil-exporting developing economies with similar features. In particular, the model is also capable of incorporating different degrees of international capital mobility, along with the adoption of either a fixed or flexible nominal exchange rate regime. The results from this paper suggest that the impact on the competitiveness of non-oil exports from oil related shocks can be mitigated with a flexible nominal exchange rate system as the real exchange rate only slightly appreciates throughout the adjustment path. Thus, Dutch disease effects in the Libyan economy during its current period of oil production rehabilitation can be potentially reduced by moving from a fixed to more flexible exchange rate regime. In addition, the flexible nominal exchange rate benefits the private sector and offers larger benefits to non-oil production, arising from a larger accumulation of public physical capital stock, human capital stock, imported capital stock, and private capital stock