Wealth Effect and Cost Push Effect of Oil Price Shock in Iranian Economy: A New-Keynesian Approach

According to standard new Keynesian theory; an oil price shock pushes costs and increases inflation while lowers output. This relationship is modeled by an improved new Keynesian Philips curve for oil importing countries. However, oil price shock in the oil exporting countries has an additional channel of transmission through oil revenues called wealth effect. This channel do not exists in the standard new Keynesian Philips curve. In this paper, we add oil sector to the standard two-sector new-Keynesian model in order to analyze the cost push and wealth effect of oil price shock in Iranian economy. The developed new Keynesian Philips curve for oil exporting countries in this model depends on real wage, oil price, productivity of both sectors and oil revenues. The dynamic stochastic general equilibrium model is calibrated based on Iranian economy parameters and then solved for impulse response functions. Our results show that wealth effect of oil price shock on inflation is higher due to lower oil share in short term production function and controlled oil prices. The increasing impact of wealth effect on consumption in this model is more than the decreasing effect of cost push. Although labor supply lowers slightly after oil price shock the overall effect on employment and real wages are negative. Consequently, it can be concluded that Iranian economy enters a stagflation after an oil price shock with consumption growth and lower real wages.