RDP 2013-14: Reserves of Natural Resources in a Small Open Economy 6. Conclusion

This paper examines whether the assumption of an exogenous stock of natural resources is innocuous in the context of a small open economy model. Our findings suggest that the standard exogenous reserves approximation is reasonable for quantifying the effects of a commodity or resource price shock on key prices of interest including the real exchange rate, consumer prices and the domestic interest rate.

However, our results also imply that the standard approach is likely to under-estimate the effects of a resource price shock on the resource sector itself, with larger expansions in investment, labour utilisation and production occurring when reserves are responsive to exploration activity. Consistent with this, we also find that the effects of a resource price shock on the domestic allocation of productive inputs across sectors are larger under the assumption of endogenous reserves. This is because the resource sector absorbs domestic inputs into production and so consumption and non-resource export production both grow by less (relative to the baseline of a balanced growth path). The net effect on domestic production with endogenous reserves is, nevertheless, small.