The falling oil price

The plummeting oil price is one of the major economic events that will affect the world economy in 2016. For students of economics it is impossible to ignore. (Note for Australian students the parallel with commodity prices should be obvious.)

The chart, from Tradingeconomics.com, shows the oil price for the last five years. The fall from $110 to $30 a barrel will impact the economies of every nation because oil is fundamental to the worlds energy supply. However the impact on each country is going to be different.

This is a huge subject and so today I will concentrate on Russia as an example, a major oil exporter.

It is fair to say that in the last twenty years oil and gas exports have allowed the Russian economy to expand and the standard of living of Russians has been improved due to this. In terms of macroeconomics Russia's net exports (X - M) has boosted Aggregate Demand (AD) and taxes on oil and gas (collected in a variety of ways) have funded a large proportion of Russia's government spending (G).

The fall in the oil price is disastrous for Russia. As net exports fall so does AD. The government finds that its revenue is falling and they must cut government expenditure to cope with their budget deficit, and so reduce AD further.

But the story is the exact opposite if you are an oil importer. Next exports will rise, as the cost of imports fall, shifting AD to the right. Also energy costs are an important part of firms costs and so AS moves to the right too.

So the result for Russia and other exporters, such as Venezuela, is a budget crisis,  lower output, higher unemployment and possible deflation. Oil importers may see higher growth and employment.

There are other effects and considerations, not the least of which is the implication for exchange rates (see article).  For now we will leave it at the initial effects on the AD/AS model and a classic example of an 'asymmetric shock' - the same event affecting countries in opposite ways.

The BBC cover the effect on Russia here

Questions:
1. What are the implications for the macroeconomic goals of Russia of the oil price fall.
2. How should Russia's economic policy mix change as a result?
3. What are the implications for the macroeconomic goals of non-oil producers of the oil price fall.
4. How should non-oil producers economic policy mix change as a result?
5. How can exchange rates help 'soften the blow' of the oil price shock?

This story is very applicable to IB with many avenues for an IA on trade and exchange rates as well as macroeconomics. If falling oil prices are chosen for an IA then students would be well advised to focus on just one aspect.
For VCE there are clearly lessons that can be applied to falling commodity prices.