The effects of macroeconomic shocks on the Brunei economy: a sign restriction approach

ABSTRACT

This paper examines the impact of oil price, foreign monetary policy, and domestic government spending shocks on the Brunei economy from 2003Q1 to 2014Q3 based on a structural vector autoregression model with shocks identified using the sign restriction methodology. The results show that an unanticipated oil price decline has a negative effect on government expenditure, and consequently non-oil GDP. Foreign monetary policy shocks also affect the economy through their impact on the interest rate, prices, and the real exchange rate. The procyclical fiscal stance, which exacerbates the business cycle, is an important source of macroeconomic fluctuations. Government expenditure smoothing should be accorded high importance in the conduct of fiscal policy. This could be achieved by using oil reserve funds to finance budget deficits to delink government spending from volatile oil revenue.

KEYWORDS:

• Structural VAR
• sign restrictions
• oil price
• monetary policy
• fiscal policy
• Brunei Darussalam

JEL CLASSIFICATION:

• C32
• E32
• E62
• F41
• Q43

Acknowledgments

I thank Warwick McKibbin, Renée Fry-McKibbin, and Joshua Chan for guidance and advice. I am also grateful for comments and suggestions from two anonymous reviewers.

Disclosure statement

I declare that there are no other relevant or material financial interests that relate to the research described in this paper.

Notes

1. Ramey (2016) provides an excellent synthesis on identifying macroeconomic shocks.

2. The price and exchange rate puzzles exist when an unanticipated contractionary monetary policy leads to an increase in inflation and a real exchange rate depreciation, respectively.

3. The correlation between the international crude oil price and Brunei's oil production is 0.60 over the period 1994Q1–2005Q4, but becomes 0.00 over the period 2006Q1–2015Q3.

4. The correlation between real non-oil GDP and real government expenditure from 2003Q1 to 2014Q3 is 0.80.

5. Brunei is one of the very few countries in the world with no external debt. Brunei began issuing domestic Islamic bonds (Sukuk Al-Ijarah) in 2006. As of 2015, the outstanding public debt is less than 3% of GDP.

6. Brunei's sovereign wealth fund was set up in 1983 under the auspices of the Brunei Investment Agency (BIA), and the assets under management are currently estimated at US$40 billion (SWFI 2016). A fiscal stabilization reserve fund was established in 2008 with the objective of making up for government revenue shortfalls.

7. The Currency Interchangeability Arrangement (CIA) between Brunei and Singapore was signed in 1967 and remains in effect, in which the two currencies are customary tender.

8. Brunei has adopted a new series of national accounts with base year 2010, but revisions of past data series are only available from 2010. This paper uses data with base year 2000 to allow a sufficiently long time series for econometric analysis. As such, GDP data is available only from 2003Q1 to 2014Q3.

9. Recent literature on the oil price--macroeconomy relationship focuses on the underlying sources of an oil price shock. Kilian (2009) finds that the main cause of oil price movements after 2003 is due to global demand shocks. Given the time period considered in this paper, it is reasonable to expect an expansionary monetary policy in Singapore in response to a fall in oil prices caused by slowing global demand.

10. The price and exchange rate puzzles are not observed here. Jääskelä and Jennings (2011) find that sign-restricted VAR models seem to be able to overcome exchange rate puzzles.

11. A maximum of two lags is used due to the relatively short time series data. Using three or more lags produce highly imprecise impulse responses.

Additional information

Funding

This work was supported by the Centre for Strategic and Policy Studies, Brunei Darussalam.

Notes on contributors

Wee Chian Koh

Wee Chian Koh is a PhD Economics scholar at the Crawford School of Public Policy at the Australian National University and also an associate researcher at the Centre for Strategic and Policy Studies in Brunei Darussalam. His current research interests are in empirical macroeconomics focusing on oil-exporting countries.