Abstract
We study the impact of oil price fluctuations on oil-importing developing economies focusing on Armenia and Georgia as examples of a small open economy. Our analysis takes into account the underlying sources of the increase in oil prices and the structure of energy flows.
Our objective is to understand the role of oil price jumps in the context of endogeneity of oil prices to global economic activity and to identify the key channels of transmission (compared to the developed countries). Using the methodology of Kilian (2009a), we decompose the oil price shocks based on the original source of the increase.
We conclude that accounting for underlying reasons for the increase in oil prices in the world energy markets is important for understanding the impact of oil shocks on the small open economies under study. The identified responses of key macroeconomic variables suggest that demand channel may be an important transmission factor.
Given the high share of food items in the CPI of the developing economies under study, increased world real activity is likely to translate into increased food prices directly as well as indirectly through higher oil prices. The structure of energy flows and the politics of natural gas matter for the transmission of oil shocks.