Comment on J. F. Helliwell, P. M. Boothe and R. N. McRae, “Stabilization, Allocation and the 1970s Oil Price Shocks”

Abstract

It is well known that the small open economy can protect itself from external shocks in various ways. In the 1970s, we have witnessed the attempts of a number of small countries (e.g. Canada, Australia and the Scandinavian countries) to cushion the effects of the oil price shocks. These attempts have met with varying degrees of success (or failure) from a stabilization point of view. The inflationary effects of the oil price rise have been allowed to reach the domestic economy only gradually through exchange rate adjustments or price control schemes; domestic aggregate demand and employment have been maintained through expansionary fiscal and monetary policy. Such stabilization is obviously bought at a cost. The oil price rises are generally considered to have caused a substantial permanent change in the relative price of energy in the world. For a small country to ignore and try to avoid this signal from the world market will sooner or later lead to serious losses in allocational efficiency. Although this trade-off between stabilization and efficiency is a simple and generally accepted truth, there are, to my knowledge, very few attempts to quantify it.