Abstract:
Motivated by the necessity to maintain price stability as a precondition for achieving a stable macroeconomic environment, this study revisits the dynamics of price inflation in an oil-producing economy, concentrating on fundamentals such as oil prices and exchange rates. We extend the augmented Phillips curve model, with oil prices as a gauge of supply-side and cost-push inflation, to include the asymmetric dynamics of the exchange rate using the nonlinear ARDL (NARDL) model to arrive at the following empirical findings: First, we report that the oil price has the potential to cause declining inflation, but mainly in the short run and when it has no significant interaction with the exchange rate. Second, we find that inflation responds differently to exchange rate depreciation and appreciation, thus confirming that asymmetries matter in the inflationary effects of exchange rates. Finally, we find that exchange rate appreciation rather than depreciation has the potential to induce the inflationary effect of oil prices. Thus, while higher revenue associated with an increasing oil price tends to put oil exporting economies at an advantage, such that the oil price has little or no significant inflationary effect, it is instructive that this position may not be entirely valid for an oil exporting economy that is also characterised by high import dependence.