| Oil shocks matter. Yet, debates about the transmission mechanisms of such shocks to the macro-economy are still ongoing in the field. In this study I review, both empirically and theoretically, the role of government expenditures in smoothing out business cycles after an oil shock in six OECD countries. In the sample, empirical evidence show little support for output stabilization via the use of fiscal policy. Theoretically, within a dynamic stochastic general equilibrium model I show that, after an oil shock, a substantial reduction in output fluctuations can be achieved via the use of countercyclical fiscal policy. However, due to the modeling of government expenditures and the lack of market imperfections, output stabilization is not desirable in the model. Extending the model to incorporate the latter would potentially determine states where output stabilization becomes desirable. Last, by conducting a Golden Rule analysis, I show that utility maximization in Canada occurs when capital is subsidized while oil and labor are heavily taxed. |
