Oil Pricea

IFN Working Paper No. 810, 2009

Oil Prices and Real Exchange Rate Volatility in Oil-Exporting Economies: The Role of Governance Johanna Rickne

Research Institute of Industrial Economics P.O. Box 55665 SE-102 15 Stockholm, Sweden info@ifn.se www.ifn.se

Oil Prices and Real Exchange Rate Volatility in Oil-Exporting Economies: The Role of Governance

Johanna Rickne * September 22, 2009

Abstract Institutional and political characteristics affect the extent to which the real exchange rates of oil-exporting countries co-move with the oil price. In a simple theoretical model, good governance insulates real exchange rates from price volatility by generating a smoother pattern of fiscal spending over the resource price cycle. Empirical tests on a panel of 33 oil-exporting countries provide evidence that countries with high bureaucratic quality, strong and impartial legal systems, democratic governing systems, and more equal income distributions have real exchange rates which co-move less with the oil price. Keywords: Real exchange rate, commodity price, governance, cross-country regression, development JEL Classification: F31, Q48, H11

Department of Economics, Uppsala University, P.O. Box 513, SE-75120, Uppsala, Sweden; Research Institute of Industrial Economics (IFN), P.O. Box 55665, SE-10215, Stockholm, Sweden; Email:

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1. Introduction

In many ways, a natural resource is a gift from nature. At least in theory, it can be taxed without harming the incentives to produce, and tax revenue can then be spent on importing the capital goods needed for economic modernization. Empirical research however shows that countries which are amply endowed with natural resources often grow slower than others (Sachs and Warner, 1995; Auty, 2001). One economic explanation for this paradoxical phenomenon is that the real exchange rates of resource exporting economies co-move with commodity prices. In real exchange rate upturns, the competitiveness of the...