Jean Pierre Allegret

Mohamed Tahar Benkhodja

External Shocks and Monetary Policy in a Small Open Oil Exporting Economy

Keywords: Monetary policy, external shocks, oil exporting economy, Algeria, DSGE model. JEL codes: E3, E5, F4

To investigate the dynamic e¤ect of external shocks on an oil exporting economy, we estimate, using Bayesian approach, a DSGE model based on the features of the Algerian economy. The main purpose is to investigate the dynamic e¤ect of four external shocks (oil price shock, USD/EUR exchange rate shock, international in- ‡ation shock and international interest rate shock) and to examine the appropriate monetary policy strategy for Algerian economy, given its structural characteristics and the pattern of the external shocks. We analyze the impulse response functions of our external shocks according to alternative monetary rules. The welfare cost associated with each monetary policy rule has been considered. Our main …ndings show that, over the period 1990Q1-2010Q4, core in ‡ation monetary rule allows better to stabilize both output and in ‡ation. This rule also appears to be the best way to improve a social welfare.

Introduction

Emerging and developing economies are especially vulnerable to external shocks. Many channels explain such vulnerability. First of all, these countries remain dependent from Corresponding author: EconomiX, UMR CNRS and Université Paris Ouest Nanterre La Défense. Email: jallegret@u-paris10.fr. Tel.: +33 (0) 1.40.97.59.07 Fax: +33 (0) 1.40.97.41.98 Professionnal adress: Université Paris Ouest Nanterre La Défense Building G, O¢ ce 603b, 200 avenue de la République 92001 Nanterre Cedex France.

y Université Lyon 2. E-mail : benkhodja@gate.cnrs.fr. Tel. : +33 (0) 4.37.37.65.77 Fax : +33 (0)4.37.37.60. [START_REF] Yun | Nominal Price Rigidity, Money Supply Endogeneity, and the Business Cycles[END_REF] École Normale Supérieure de Lyon, GATE-CNRS. Bureau R130 15, Parvis René Descartes 69342 Lyon cedex 07 France 1 economic activity in industrialized countries (the trade channel) and from international capital markets -including international banking activity-to …nance their investment (the …nancial channel). In addition, despite a declining trend since the last decade, domestic prices in emerging and developing countries remain in ‡uenced by exchange rates ‡uctuations (the pass-through channel). Within this group of economies, oil exporting countries are even more exposed to these shocks. Indeed, oil exporting economies rely heavily on oil for their exports earnings, and their growth portrays a strong dependence for imports. As a consequence, they tend to have more volatile business cycle and are more crisis prone than other small-open economies. In this paper, we focus our attention on a speci…c oil exporter: Algeria. Relatively to other upper middle countries, Algeria is a relatively opened economy. In 2009, the exports of goods and services in terms of GDP amounted to 40.4 percent in Algeria while this ratio was 27.4 for upper middle countries (World dataBank website). Trade openness is higher: 76.5 percent in Algeria against 52.6 percent in upper middle income countries 1 . In addition, as reported by [START_REF] Dib | Dynamic E¤ects of the U.S. Dollar Fluctuations in a Small Open Oil Exporting Economy: The Case of Algeria[END_REF], this country has features that may intensify its responsiveness to external disturbances:

(i) a managed exchange rate regime in which the dollar is the currency peg; (ii) a very strong concentration of its exports (oil accounts for more than 95% of its exports) with prices denominated in the U.S. dollar and set in the world markets; (iii) imports whose the major part (65%) is invoiced in euro; (iv) a net debtor position vis-à-vis the rest of the world; (v) a relatively diversi…ed currency composition of its foreign debt since at least 60% of this debt has been issued in currencies other than the U.S. dollar; and (vi) a current account position highly dependent on oil-price ‡uctuations.

Over the period 2000-2010, despite signi…cant oil revenues, economic performances in Algeria have been far from impressive. On the one hand, the average real GDP change amounted to 3.6 percent, consistently below growth performances in MENA region (5.6 percent) 2 . Interestingly, the activity rebound in 2010-relatively to the trough of 2009-has been signi…cantly below in Algeria relative to MENA countries (0.8 percentage points and 2.6 respectively). On the other hand, in the aftermath of the 1994 stabilization program,

Algerian in ‡ation rate converged towards in ‡ation levels in MENA region. In ‡ation has been stabilized in Algeria insofar as its in ‡ation performances are close to the ones in other MENA countries (3.1 percent and 3.4 respectively over the period 2000-2010) 3 .

Since 2006, despite a signi…cant increase in the in ‡ation rate -the consumption price index increased from 0.3 in 2006Q1 to 7.3 in 2008Q2 leading to a signi…cant decrease in the in ‡ation di¤erential-Algeria remains one the best performers in MENA region. But this outcome is not striking if we take into account the unimpressive growth performance.

The previous structural characteristics of the Algerian economy and its economic performances raise the question of the appropriate monetary policy for this country.

Focusing on the pattern of external shocks, it is the main purpose of this paper. To investigate the dynamic e¤ect of external shocks, several studies have used econometric models, in particular VAR models, to decompose the direct e¤ects of external shocks on output and other variables, from those generated by the endogenous monetary policy response as in [START_REF] Hamilton | Oil and the Macroeconomy Since World War II[END_REF]; [START_REF] Bernanke | Systematic Monetary Policy and the E¤ects of Oil Price Shocks[END_REF]; [START_REF] Hamilton | Oil Shocks and Aggregate Macroeconomic Behavior: The Role of Monetary Policy[END_REF], among others. All of these studies have investigated the e¤ect of oil price shocks on output for the U.S. and the role played by the monetary policy. Other studies like Leduc and Sill (2001), [START_REF] Medina | Oil Shocks and Monetary Policy in an Estimated DSGE Model for a Small Open Economy[END_REF] and [START_REF] Devereux | Exchange Rate and Monetary Policy in Emerging Market Economies[END_REF] have developed DSGE models to study the macroeconomic implications of alternative monetary policy rules, after external shocks, for a small open economy. [START_REF] Medina | Oil Shocks and Monetary Policy in an Estimated DSGE Model for a Small Open Economy[END_REF] analyzed the e¤ects of oil price shocks under alternative monetary policy rules. The authors developed and estimated a DSGE model by Bayesian methods for Chilean economy. The main results show that an increase in the real price of oil leads to a fall in output and an increase in in ‡ation. The contractionary e¤ect of the oil shock is mainly due to the endogenous tightening of the monetary policy. [START_REF] Devereux | Exchange Rate and Monetary Policy in Emerging Market Economies[END_REF] compared alternative monetary policies for an emerging market economy that experienced external shocks to interest rates and terms of trade. They investigated, in particular, the importance of exchange rate ‡exibility in implementing such rules (a …xed exchange rate rule; and two types of in ‡ation targeting rules). Their main …nding is that degree of pass-through in import prices is crucial in determining the stabilization properties of an in ‡ation targeting regime. Also, …nancial distortions amplify external shocks but have little impact on the ranking of alternative policy regimes.

We estimate, by using the Bayesian approach, a DSGE model for Algerian economy investigating the dynamic e¤ect of four external shocks (oil price, real exchange rate, international interest rate and foreign in ‡ation), and examining the appropriate monetary policy rule. To do so, we develop a Multisector Dynamic, Stochastic, General equilibrium (MDSGE) model with real and nominal rigidities. The aim is, …rst, to compare the importance of each shock as a source of ‡uctuations of the Algerian economy and their welfare implications and secondly, to de…ne the appropriate monetary policy rule that insulates the economy from the impacts of these shocks. Our model is di¤erent from the previous literature in many aspects. First, given that in several oil exporting countries, government aims to smooth oil price changes, we assume that the domestic oil price is de…ned by a convex combination of the current world price expressed in local currency and the last period's domestic price. This rule allows us to replicate the subsidy of oil price that is a common practice in Algeria. Second, in our model there are two exchange rates: US dollar/Algerian dinar and the euro/US dollar real exchange rates. The …rst exchange rate is the exports'currency and the second represents a part of the imports' currency. Third, our model is a small open oil exporting economy model for a number of reasons: (i) the model is a multisector DSGE model with an oil sector; (ii) oil resource is used in the production function of the oil …rm; (iii) the re…ned oil is used as an input in non-oil production, and (iv) oil price is subsidized.

In addition to these features, prices are sticky in the non-oil and import sectors. This allows monetary policy to play a role in our model. Indeed, this assumption is crucial in order to investigate the role of monetary policy in a DSGE model. We consider three alternative monetary policy rules: a …xed exchange rate rule, an headline in ‡ation targeting rule, and a core in ‡ation targeting rule. We adopt these rules for two main reasons: (i) they describe the conduct of monetary policy in a large number of developing and emerging market economies; and (ii) in the oil exporting economy, the presence of the oil component in headline CPI in ‡ation engenders the question whether the measure of in ‡ation in Algeria should be the headline in ‡ation or the core in ‡ation. In other words, does monetary policy in Algeria react to the headline in ‡ation or the core in ‡ation?

Our main …ndings show that, over the period 1990Q1-2010Q4, core in ‡ation monetary rule allows better to stabilize both output and in ‡ation. This rule also appears to be the best way to improve a social welfare.

The rest of the paper is organized as follows. In section 2 we present the details of the model. Section 3 discusses the parameters calibration, data and priors. Section 4 presents the estimation results. Section 5 measures the welfare e¤ect of the external shocks under alternative monetary policy rules. Section 6 concludes.

The model

In this section we model an oil exporting economy based on the features of the Algerian economy. To do so, we assume that the economy is inhabited by seven agents: household, oil producing …rm, non-oil goods producers, intermediate foreign goods import, …nal good producer, a central bank and a government.

The household has access to international …nancial markets where it can buy or sell foreign non-state contingent bonds. In oil sector, there is a single perfectly competitive …rm producing oil output, while in the non-oil goods and imports sectors, there are a continuum of monopolistically-competitive …rms. This …rms set their prices à la [START_REF] Calvo | Staggered Prices in a Utility-Maximizing Framework[END_REF] and [START_REF] Yun | Nominal Price Rigidity, Money Supply Endogeneity, and the Business Cycles[END_REF]. As to the …nal good producer, it operates under perfect competition.

It is assumed that the central bank adjusts the short-term nominal interest rate in response to ‡uctuations in in ‡ation in the non-oil goods sector (core in ‡ation), CPI in ‡ation, and nominal exchange rate, using Taylor-type monetary policy rule. The government is considered as the owner of the oil …rm.

Household

The representative household derives utility from consumption c t and leisure (1 h t ):The preference of household is described by the following expected utility function:

E 0 1 X t=0 t U (c t ; h t ) ; (1)
where denotes the subjective discount factor (0 < < 1) :We assume that, u (:), the instantaneous utility function, is speci…ed by:

u (:) = c 1 t 1 h 1+ t 1 + ; (2)
where the preference parameters and are strictly positive. The …rst parameter, , is the inverse of the elasticity of intertemporal substitution of consumption and the second parameter, , denotes the inverse of the wage elasticity of labor supply. The single utility function, u(:), is supposed to be strictly concave, strictly increasing in c t and strictly decreasing in h t :We also assume that h t is de…ned by the following Cobb-Douglas technology:

h t = h ho o;t h hno no;t ; (3)
where h o;t and h no;t represent hours worked by the household at time t in oil and non-oil sectors respectively. The parameters ho and hno denote the labor elasticity of substitution in the oil and non-oil sectors respectively, where ho + hno = 1:

The representative household has access to domestic and international …nancial markets. It enters in period t with holdings of domestic bonds denominated in units domestic currency (Algerian dinar), B d t 1 , and foreign non-state contingent bonds, B f t 1 , denom-inated in foreign currency.

During period t, the household pays a lump-sum tax, $, to …nance government spending and sell or buy, B f t , at a price that depends on a country speci…c risk premium and the international interest rate R f t t 1 : In other words, buying foreign bonds entails paying a risk premium, t , whose the functional form is given by:

t = exp 0 @ e t t f B f t =P f t P t Y t 1 A ; (4)
where denotes the parameter measuring the risk premium, e t and t are two exchange rates 4 : the US dollar/ Algerian dinar (USD/DZD hereafter) and the euro/US dollar (EUR/USD hereafter) respectively and f B f t is the average nominal stock of external debt which takes either a positive value if the domestic economy is a net borrower or negative value if the domestic economy is a net lender 5 . In our case, we assume that B f t < 0 to the extent that the Algerian economy is net borrower. Note …nally that Y t is the total real GDP and P f t is the foreign price index. By following this functional form, the model would not have a unit root because the holding bond would not follow a random walk 6 . The risk premium also ensures that the model has a unique steady state.

The representative household, in period t, earns nominal wages, W o;t and W no;t for their labor supply, respectively in the oil and non-oil sectors. It also receives dividend payments from both non-oil, D no;t ;and import, D I;t ;sectors so that D t = D no;t + D I;t : At last, the household accumulates k o;t and k no;t units of capital stocks, used in the oil and non-oil sectors for nominal rental Q o;t and Q no;t respectively. The evolution of capital stock in each sector is given by:

k j;t+1 = (1 )k j;t + i j;t j (k j;t+1 ; k j;t ) ; f orj = o; no (5)
where is the common depreciation rate to all sectors (0 < < 1) and j;t (k j;t+1 , k j;t ) is capital-adjustment cost paid by household and satisfy j (0) = 0; 0 j (:) > 0 and 00 j (:) < 0:The functional form of j (:) is given, following [START_REF] Ireland | Endogenous Money or Sticky Prices?[END_REF], by:

j;t (:) = j 2 k j;t+1 k j;t 1 2 k j;t ; (6)
for j=o,no

The presence of the capital adjustment cost implies that, out of the steady state, the price of newly installed capital di¤ers from the price of investment goods. In other words, the Tobin's Q is di¤erent from 1. This form allows to have both total and marginal costs of adjusting capital equal to zero in the steady state equilibrium.

The expenditure and revenues presented above give the following household's budget constraint:

P t (c t + i t ) + B d t R t + e t
Finally, note that variables R f t , f t and t which represent respectively the foreign interest rate, the world in ‡ation rate and the EUR/USD exchange rate evolve exogenously according to the following AR(1) process:

log(R f t ) = (1 R f ) log(R f ) + R f log(R f t 1 ) + " R f ;t (14)
log( f t ) = (1 f ) log( f ) + f log( f t 1 ) + " f ;t (15)
log( t ) = ( 1) log( ) + log( t 1 ) + " ;t [START_REF] Leduc | A Quantitative Analysis of Oil-Price Shocks, Systematic Monetary Policy, and Economic Downturns[END_REF] where R f , f and are steady state values of R f t , f t , and t : R f , f and are the autocorrelation coe¢ cients, and " R f ;t , " f ;t and " ;t are uncorrelated and normally distributed innovations with zero mean and standard deviations R f , f and respectively:

Oil sector

To model oil production, we assume that oil …rm operating in perfect competition uses [START_REF] Parrado | In ‡ation Targeting and Exchange Rate Rules in an Open Economy[END_REF].

The …rst order conditions are: Pt denote respectively the real capital return, the real wage, the real oil price and the real price of the oil resource.

q o;t = o s t p f o;t Y o;t k o;t ; (19)
w o;t = o s t p f o;t Y o;t h o;t ; (20)
The equations ( 19)-( 21) represent the demand for k o;t ; h o;t and O t respectively. These results can be interpreted as the optimal choices of input that maximize oil producer's pro…t whose the value is equal to zero because of the perfect competition's assumption and the constant-return-to-scale production function.

Note, …nally, that foreign oil's price, P f o;t , oil resource, O t , and technology shock, A o;t , evolutions are given by the following stochastic process:

log(P f o;t ) = (1 P f o ) log(P f o ) + P f o log(P f o;t 1 ) + " P f o ;t ; (22)
log(O t ) = (1 O ) log(O) + O log(O t 1 ) + " O;t ; (23

Non-oil sector

In this sector, we assume that the non-oil producers operate under monopolistic competition. Under this assumption, it's assumed that there is a continuum of …rms indexed by i 2 (0; 1) : Each …rm i, produces non-oil goods using the following production function:

Y no;t (i) A no;t k no no;t (i) h no no;t (i) Y I no o;t (i) ; (25)
where k no;t (i) ; h no;t (i) and Y I o;t (i) are used by …rms to produce the non-oil goods. A no;t is a technology shock speci…c to the non-oil sector. This shock follows the stochastic process given by:

log(A no;t ) = (1 Ano ) log(A no ) + Ano log(A no;t 1 ) + " Ano;t ; (26)
Note also that no ; no and no 2 (0; 1) and no + no + no = 1:These coe¢ cients denote respectively a share of capital, k no;t , labor, h no;t and re…ned oil, Y I o;t , used as an input in the production of non-oil goods.

To maximize its pro…t, the producer i chooses K no;t (i) ; h no;t (i) and Y I o;t (i) and sets its price, e P no;t (i) à la [START_REF] Calvo | Staggered Prices in a Utility-Maximizing Framework[END_REF] and [START_REF] Yun | Nominal Price Rigidity, Money Supply Endogeneity, and the Business Cycles[END_REF]. Following a stochastic time dependent rule of [START_REF] Calvo | Staggered Prices in a Utility-Maximizing Framework[END_REF], the producer faces, in each period, a constant probability of changing its price. This probability is given by (1 no ) :Therefore, on average, the non-oil price remains unchanged for 1 1 no periods. As in [START_REF] Yun | Nominal Price Rigidity, Money Supply Endogeneity, and the Business Cycles[END_REF], we assume that if non-oil goods producers are not able to change their price, they index them to the steady state CPI in ‡ation rate according to the following rule:

P no;t = P no;t 1 ;
where is the long run average gross rate of in ‡ation.

The non-oil …rms'maximization problem can be written as follow:

max kno;t(i);hno;t(i);Pno;t(i) E 0 1 X s=0 [( no ) s t+s D no;t+s (i)=P t+s ]; (27)
subject to (25) and the following demand function

Y no;t+s (i) = s e P no;t (i) P no;t+s ! # Y no;t+s ; (28)
where D no;t+s (i) is the pro…t function:

D no;t+s (i) = s e P no;t (i) Y no;t+s (i) Q no;t+s k no;t+s (i) W no;t+s h no;t+s (i) P o;t Y I o;t+s (i) ;
with ( s t+s ) the producer's discount factor and t+s the marginal utility of consumption in period t + s:

The …rst order conditions of the maximization problem are: Pt denote respectively the real capital return, the real wage, the real marginal cost, and the real domestic oil price.

q no;t = no Y no;t (i) k no;t (i) mc no;t ; (29)
w no;t = no Y no;t (i) h no;t (i) mc no;t ; (30)
The real marginal cost, mc no;t , can be obtain by replacing Eqs. ( 29)-( 31) in (25):

mc no;t = q no no;t w no no;t p no : (32)
The optimal pricing condition is given by the maximization of ( 27): and t+s = P t+s Pt denote respectively the relative price of non-oil goods, the real marginal cost in non-oil sector, the real optimized price for non-oil goods and the CPI in ‡ation rate.

e p no;t (i) = # # 1 E 0 1 X s=0 ( no ) s t+s Y no;t+s p # no;t+s mc no;t+s s Y k=1 s# # t+k E 0 1 X s=0 ( no ) s t+s Y no;t+s p # no;t+s s Y k=1 s(1 #) # 1 t+k ; (33
The aggregate nominal non-oil price index evolves according to the following recursive form:

(P no;t ) 1 # = no ( P no;t 1 ) 1 # + (1 no ) e P no;t 1 # ; (34)
Dividing (34) by P t yields the following real non-tradable price index:

(p no;t ) 1 # = no p no;t 1 t 1 # + (1 no ) (e p no;t ) 1 # : (35)

Import sector

The …nal good producer uses, for its production needs, an imported composite good, Y I;t , purchased in a domestic monopolistically competitive market. To produce Y I;t , the …rm uses di¤erentiated goods, Y I;t (i), that are produced by a continuum of domestic importers, indexed by i 2 (0; 1), using a homogeneous intermediate good produced abroad and imported for the world price P f t . A part of these imported goods is denominated in euro, while another part ( 1) is invoiced in U.S dollar. The di¤erentiated goods are sold at price P I;t (i) which is supposed to be sticky à la [START_REF] Calvo | Staggered Prices in a Utility-Maximizing Framework[END_REF] and [START_REF] Yun | Nominal Price Rigidity, Money Supply Endogeneity, and the Business Cycles[END_REF].

Therefore, the importer faces, in each period, a constant probability, (1 I ), of changing its price as in [START_REF] Calvo | Staggered Prices in a Utility-Maximizing Framework[END_REF]. Following [START_REF] Yun | Nominal Price Rigidity, Money Supply Endogeneity, and the Business Cycles[END_REF], we assume that if importers are not able to change their price, they index them to the steady state CPI in ‡ation rate.

The maximization problem of importers can be written as follows:

max e P I;t (i) E 0 1 X s=0 ( I ) s t+s s e P I;t (i) e t+s ( + (1 ) t ) P f t+s Y I;t+s (i) ; (36)
where Y I;t+s (i) is chosen by …rms to maximize their pro…t:

Y I;t+s (i) = s e P I;t (i) P I;t+s ! # Y I;t+s ; (37)
The zero pro…t condition gives the importer price index:

P I;t+s = Z 1 0 s e P I;t (i) 1 # di 1 1 # ;
(38) replacing (37) in (36) and following the same steps than for the non-oil sector, we get the optimal pricing condition given by: is the optimized price in import sector and t+s = P t+s Pt is the CPI in ‡ation rate. The aggregate nominal import price index evolves according to the following recursive form:

e p I;t (i) = # # 1 E 0 1 X s=0 ( I )
(P I;t ) 1 # = I ( P I;t 1 ) 1 # + (1 I ) e P nT;t 1 # ; (40)
Dividing (40) by P t yields the following real import price index:

(p I;t ) 1 # = I p I;t 1 t 1 # + (1 I ) (e p I;t ) 1 # : (41)

Final good producer

We assume that the producer of …nal good operates under perfect competition. It uses the following CES technology that includes non-oil output, Y no;t , which is domesticallyproduced, and imports, Y I;t :

z t = 1 no Y 1 no + 1 I Y 1 I 1 ; (42)
where > 0 denotes the elasticity of substitution between non-oil output and imported goods and no ; I represent respectively the share of non-oil and imported goods in the …nal good, where no + I = 1: To maximize its pro…t, the …nal good producer

Government

In an oil exporting economy 7 , the oil domestically used (re…ned oil), Y I o;t , is produced abroad. As a result, we assume that government, which is the owner of the oil …rm, buys it from the world market for the international price, P f o;t , denominated in the foreign currency.

The re…ned oil is sold domestically to the non-oil …rms at price P o;t which can be considered as the domestic fuel price. The latter is supposed to be subsidized by the government. For this purpose, we assume according to [START_REF] Bouakez | Optimal Pass-Through of Oil Prices in an Economy with Nominal Rigidities[END_REF] and [START_REF] Benkhodja | Monetary Policy and the Dutch Disease in a Small Open Oil Exporting Economy[END_REF], that the domestic oil price, P o;t is given by a convex combination of the current world price,P f o;t , expressed in local currency and last period's domestic price. It follows the following functional form:

P o;t = (1 )P o;t 1 + e t t P f o;t ; (46)
where 2 (0; 1) ; and P f o;t denotes the world price of oil that is determined in the world market and denominated in the foreign currency.

Following the oil price rule, when = 1; there is no subsidy and the pass-through from the world oil price is complete. However, when = 0; this means that the domestic oil price is fully subsidized and there is no pass-through. Thus, all domestic …rms will buy the oil at a price P o;t :

Finally, the government's budget constraint is given by: $ X

Aggregation and Equilibrium

In a symmetric equilibrium, all importers and non-oil goods producers make the same decision so that:

Y no;t (i) = Y no;t , Y I o;t (i) = Y I o;t ,
Combining the households' budget constraint, the single period pro…t functions of non-oil goods producing …rms and foreign good importers and the …rst order conditions of the three sectors and applying the market clearing conditions yields the following current account equation:

b f t t R f t = b f t 1 f t + p f o;t Y o;t = t p f o;t Y I o;t ( + (1 ) t ) Y I;t = t : (50)
3 Model estimation

In this section, we estimate the model by using the Bayesian method. To do so, we will describe the methodology to use, data and prior distributions.

Calibration, data and priors

The model is estimated by using the Bayesian method as in Sungbae and Schorfheide There are 30 parameters to be estimated gathered in ={ no , I , o , no , #, I ,

no , o , o , o , no , no , no , no , , e , R f , ao , ano , f , p f o , O , , R f , ao , ano , f , p f o , O , }.
The rest of the parameters are calibrated, as commonly done in the DSGE literature.

This procedure helps to cope with the problem of identi…cation from which DSGE models commonly su¤er, arising from the fact that the data used in the estimation may contain little information about some parameters.

As in [START_REF] Almeida | Bayesian Estimation of a DSGE Model for the Portuguese Economy[END_REF], the parameters we chose to calibrate pertain mostly to three aspects: (i) those crucial to determine the steady-state; (ii) those for which we have The price elasticity of demand for imported, and non-oil goods, , is set at 0,8 as in Dib (2008a). Lump-sum tax parameter, $; and the share of import invoiced in the US dollar, ; are set at 0:2 and 0:35 respectively. Indeed, following the annual economic reports of the Bank of Algeria (2009), the share of Algerian imports from the Euro Area is about 65% of total imports. Finally, we set values of the labor elasticity of substitution to match the shares of wages in the two sectors of Algerian economy (oil and non-tradable), so that, ho and hno are equal to 0; 31 and 0:69 respectively.

The steady-state of gross in ‡ation and nominal interest rates, , f , R, and R f are set equal to 1:101, 1:023, 1:134, and 1:040, respectively. These values are the annual observed averages in the data of the Algerian and Euro Area economies for the period 1990 2010. The parameter in the risk-premium terms, , is set equal to 0:0015 implying an annual risk premium of 1:35% (135 basis points). This value is consistent with the average interest rates di¤erential between Algeria and the Euro Area, and implies a steady-state foreign-debt-to-GDP ratio of 30%, which is close to that observed average ratio in the data.

To estimate the model, we use seven series of quarterly Algerian and US data from 1990-Q1 to 2010-Q4: oil production, consumption, domestic in ‡ation, the domestic real interest rate, USD/DZD real exchange rate, domestic GDP and real oil price. The oil price is the international price of WTI oil. The domestic interest rate is the discount rate computed by the Bank of Algeria to manage its monetary policy. All of these variables are de ‡ated by an index of prices for the Algerian economy.

The model implies that all variables are stationary and ‡uctuate around constant means, but the series used in the estimation are non-stationary. Thus, to render them stationary, we applied an HP-…lter and used the detrended series instead of the original ones.

To re ‡ect our beliefs about structural parameters, we specify prior distributions for the entire vector . As studies on the Algerian economy are unavailable, we choose priors based on evidence from previous studies for oil exporting economies (like Medina and Soto (2005) and Dib (2008a)). These priors are summarized in Table 2.

We assume Beta distribution for those parameters that must lie in the [0 1] interval.

This applies to the persistence parameters of the exogenous stochastic processes which are assumed to follow a beta distribution with a mean of 0:65 and a standard deviation of 0:03. The Beta distribution is also assigned to the parameters of price stickiness with a mean of 0:67 that corresponds to changing price every 3 quarters on average.

We also assume that the mean of parameters ( o ; o ; o ) and ( no ; no ; no ), which are associated with the shares of capital, labor and a fraction of oil output in the output of each sector, are set to match the average ratios observed in the Algerian data for the 1990-2010 period. We set the shares of capital, o ; labor, o , and oil resources, o , in the production of oil to 0; 31, 0; 24 and 0; 45 respectively. We also set to 0; 23, 0; 52 and 0; 25 We also assume Gamma and inverted Gamma distributions for the parameters that must be positive. This is the case of the standard errors of various innovations which are assumed to follow the inverse Gamma distribution, with a mean of 0:5 and a standard error of 2. The remaining parameters have a normal distribution. Thus, we use a normal distribution for the capital adjustment costs in each sector with a mean of 5 and a standard deviation of 2. Also, as in Rabanal and Rubio-Ramirez (2005) and Medina and Soto (2005) we do not impose non-negativity restrictions on the policy rule coe¢ cients.

the
Thus, we assume a normal distribution for all monetary policy coe¢ cients with a mean of 0:50, 0:70 and 0:60 for core in ‡ation, in ‡ation and exchange rate coe¢ cients respectively.

A standard deviation of 0:3 is assigned to these parameters.

Estimation results

In order to study the robustness of our baseline model, we begin the analysis of our results by focusing on posterior means (Table 3). Then we analyze the impulse response functions of the external shocks according to the alternative monetary policy rules.

Finally, we study the business properties of our model, included variance decomposition. Posterior means suggest a weaker price rigidity in the non-oil sector relatively to the import sector (Table 3.a). More precisely, the estimated Calvo probabilities of not resetting optimally prices are 0:64 and 0:76 respectively. That means that prices are adjusted every 2:77 quarters in the non-oil sector and every 4:16 quarters in the import sector suggesting the presence of nominal prices rigidities in the later sector. More precisely, price rigidities may be highest in Algeria relatively to other primary commodity exporters such as Chile owing to the greater in ‡uence of state concerning prices determination. In addition, it seems to us relevant to consider that the state exerts a stronger in ‡uence on the import sector than the non-oil one for two main reasons. Firstly, public and parapublic companies tend to own to the import sectors. Secondly, as stressed above, authorities subsidy the domestic price of oil, price that exert a direct in ‡uence on prices in the import sector. All this induces more rigidity in the former relative to the later. Finally, some import sectors-such as the food one-have monopolistic structures goods (0:415). Indeed, as low-diversi…ed oil-exporting countries, Algeria remains heavily dependent on imported capital goods, intermediate inputs, and also agricultural products 10 .

The baseline model

The shares of capital, labor and oil resource in the oil and non-oil sectors exhibited by posterior mean are very close to prior mean. As this latter has been estimated by using Algerian date for the period 1990 2009, the small gap between prior and posterior means shows the relevance of our baseline model to analyze the Algerian economy. Clearly, according to our baseline model, the Algerian central bank does not react to exchange rate disturbances. This very low coe¢ cient does not imply that Algerian authorities do not monitor exchange rate in their economic policy strategy. In fact, in the aftermath of the dramatic dinar devaluation in 1994 -included in the stabilization program-Algeria has adopted a de facto crawling band exchange rate regime 11 . The main aim with this intermediate regime is to maintain the real e¤ective exchange rate close to its equilibrium and to limit exchange rate volatility. Since 2002 this strategy has been successful: not only the real e¤ective exchange rate is very stable, but also the gap between the real and the nominal e¤ective exchange rates is very small. The low in ‡ationary environment has favored such result. The inconvertibility of the dinar for …nancial transactions and the small size of the heavily regulated foreign exchange market allow the central bank to not respond directly, by manipulating the interest rate, to exchange rate swings. We see that headline in ‡ation accounts for an important weight in the monetary policy ( is equal to 1:918) while the coe¢ cient associated to core in ‡ation ( no ) is extremely low ( 0:045). These coe¢ cients are in line with the practice followed by numerous central banks. They tend to target total in ‡ation instead of core in ‡ation.

The lower part of Table 3:b suggests that monetary policy in Algeria must face to a volatile environment. Interestingly, standard deviations show that international shocks -EUR/USD exchange rate, oil price, international interest rates and foreign in ‡ation-are among the main disturbances that hit this economy. In addition, it appears from the higher part of Table 3:b that shocks are also persistent. One of the main lesson of this Figures A-1). Globally speaking, responses of domestic macroeconomic aggregates are consistent with the structural characteristics of the Algerian economy. In addition, as our variables return relatively rapidly to their steady state level after a shock, our model is stationary. Our analysis focuses on contemporaneous responses to shocks.

As expected, GDP, investment and non-oil production increase after a positive oil price shock. Such response is consistent with the sensitiveness of the economy to oil sector. The negative response of oil output may rest on di¤erent factors. For this reason, the response is di¢ cult to interpret. On the one hand, it may rest on the willingness of the authorities to limit the oil supply in order to maximize the oil rent. On the other hand, as an OPEC member, Algeria can not freely modify its oil supply according to oil prices changes. As a consequence, at least in the short-run, oil output can be relatively inelastic to prices ‡uctuations. Oil price shock implies a positive wealth e¤ect for consumers. Despite the fact that the oil used domestically is re…ned mostly in foreign countries and then imported, as the authorities subsidize domestic oil products, increase Country Report n 11=39, February 2011.

in oil price has few e¤ects on the purchasing power of consumer. As a result, the main consequence of the increase in oil price is positive owing to the place of the oil sector in the economy. Sticky prices, in part due to the presence of subsidize and administrated prices explain the immediate responses of in ‡ation: while the reaction is weak for headline in ‡ation, we see a negative response for core in ‡ation. However, both measures of in ‡ation tend to increase in the aftermath of the oil shock. The contemporaneous response of current account balance is negative but it improves signi…cantly after two periods. This response rests on the strong elasticity of domestic demand to the economic activity. More precisely, the positive wealth e¤ect triggers an increase in domestic spending, and so higher imports. Later, as the value of exports improved, a current account surplus appears. Neither in ‡ation in the import sector nor the real exchange rate react to the oil price shock. Both prices stickiness and the state control explain this response in the import sector. If the real exchange rate reaction to the oil price shock contrasts with other studies on oil-exporting countries and primary commodity exporting -such studies show that the domestic currency tends to appreciate in real terms after a positive primary commodity prices shock-it is consistent with the real exchange rate stability target of the Algerian authorities.

Exchange rate shock exerts a signi…cant in ‡uence on domestic macroeconomic variables. As exports are denominated in dollar and imports mainly in euro, it is important to keep in mind that nominal exchange rate shock is equivalent to terms of trade shock.

We see that GDP, investment and non-oil production react negatively to a depreciation of the dollar against the euro. As oil prices are denominated in dollar, the very high share of the oil sector in the Algerian GDP explains the negative response of the latter.

The exchange rate shock is equivalent to a negative wealth e¤ect. In turn, the decrease in oil revenue leads to a fall in investment and non-oil output. Indeed, non-hydrocarbon sector is a¤ected by the exchange rate shock via the …scal expenditure policy which is dependent from oil revenue. The hydrocarbon stabilization fund established in 2000 has a limited impact on the pro-cyclicity of the …scal policy. In other words, the volatility of the non-oil sector is signi…cantly linked to the volatility of the oil sector. As the main trade partners of Algeria belong to the Euro area, the exchange rate shock leads to an increase in imported in ‡ation that, in turn, induces a positive response of both headline and core in ‡ation. As expected, consumption decreases on the impact of the exchange rate shock according to a negative wealth e¤ect. The current account balance strongly deteriorates. Indeed, in accordance with a J-curve e¤ect, the immediate e¤ect of the exchange rate shock is a decrease in the value of exports with the depreciation of dollar while the value of imports tends to increase with the euro appreciation. After several periods, trade volumes adjust to the shock and the current account improves. In ‡ation in the import sector does not respond to the exchange rate shock. The real exchange rate appreciates on the impact of the shock, but the response is short-lived.

Both the international interest rate and the foreign in ‡ation shocks tend to exert a weaker in ‡uence on domestic variables. The weak in ‡uence of the international interest rate rests on the relatively low level of …nancial openness of Algeria. ). Such a volatility when the economy is mainly hit by real shocks.

External shocks under alternative monetary policy rules

Figures A2 to A5 exhibit the responses of our domestic macroeconomic aggregates to four shocks: oil price, international interest rate, nominal exchange rate, and foreign in ‡ation respectively. We show the results for the baseline model and the three monetary policy rules introduced in subsection 2.6: strict in ‡ation targeting rule (IT rule), core in ‡ation targeting rule (CIT rule) and exchange rate rule (ER rule). The importance of each monetary policy will be deduced from the gap of the responses of our selected variables shown in each …gure. The aim is to determine the monetary policy rule that both minimizes the macroeconomic volatility and maintains the in ‡ation rate at a low level once we take into account the main shocks that hit this country.

E¤ects of an oil price shock

To analyze the e¤ects of oil price shock, we distinguish the responses of real macroeconomic variables and in ‡ation respectively under alternative monetary policy rules. Results on real variables show that, except for oil output, the alternative monetary policy rules provide better outcomes than the baseline model. This suggests that the current monetary policy followed by the central bank is not optimal to respond to oil price shocks. Both GDP, non-oil output, and consumption exhibit weaker contemporaneous responses under the core-in ‡ation targeting rule. We …nd no signi…cant di¤erences for investment between the two in ‡ation rules while the exchange rate rule does not allow a smooth response of this variable. Immediate responses are only one side to consider the monetary policy rule best adapted to shocks a¤ecting the economy.

The analysis of the adjustment is the other side. Adjustment refers to the speed at which a speci…c variable returns to its steady state level. Under the baseline model and the exchange rate rule, all real variables follow an unstable adjustment process. More precisely, our results shows that short-run ‡uctuations are sizeable under these two scenarios. In ‡ation targeting and core-in ‡ation targeting rules do not exhibit signi…cant di¤erent adjustment process.

Responses of headline in ‡ation and core-in ‡ation give more mixed results. On the impact of the shock, the weakest response for total in ‡ation is obtained with the baseline model while the core-in ‡ation targeting rule is the best one to limit the response of corein ‡ation. In both cases, the worst monetary policy is the exchange rate rule. The analysis of the adjustment process con…rms the latter result. Thus the exchange rate rule tends to be accompanied by sizeable short-run ‡uctuations. At the opposite, core-in ‡ation targeting o¤ers the most stable adjustment for both headline and core in ‡ation.

After the oil price shock, in ‡ation in the import sector exhibits the strongest response under the in ‡ation targeting rule. Such result con…rms …ndings in the previous literature on strict in ‡ation targeting. This monetary regime induces wide ‡uctuations of the macroeconomic variables. Interestingly, as suggested by the adjustment process, this monetary rule does not allow a rapid adjustment of in ‡ation in the import sector. The in ‡ation targeting rule exerts a weaker in ‡uence on the contemporaneous response of the real exchange rate. We …nd the opposite for the core-in ‡ation rule. But we need to be cautious to interpret these results as all alternative rules and the baseline model show only very short-lived responses of the real exchange rate to the oil price shock.

To E¤ects of international interest rate and foreign in ‡ations shocks The responses and adjustment of our variables of interest exhibit a very low reaction in the case of core in ‡ation targeting. Indeed, in the case of international interest rate and foreign in ‡ation shocks, …gure (A-4 and A-5) show that the reaction of the most of selected variables (GDP, investment, non-oil and oil output and consumption, for example) is negligible in the case of CIT rule compared to the other two monetary policy rules, namely, IT and ER rules. This result is similar to the previous two shocks.

Business cycle properties

In this section, we compare the statistical properties of the model against those of the data. To do so, we estimate a Bayesian Vector Autoregression (BVAR) model using the same data set.

Volatility and correlation

In what follows, we assess the performance of our DSGE model by considering the model implied volatilities (stabdard deviation) and correlation of some variables of interest in the data and from the model. Columns 2 and 3 display standard deviations of seven selected variables (GDP, consumption, oil output, in ‡ation, international oil price, international interest rate and real exchange rate). The main striking lesson from Table 4 is the consistency of our results. Indeed, variables with the higher volatility relative to the GDP (Y ) are also the most volatile ones in the DSGE model. The only exception is the international oil price (P f o ) for which we …nd a lower volatility in the DSGE model. In the two speci…cations, the domestic headline in ‡ation ( ) exhibit the lowest volatility. The fact that the international oil price and the headline in ‡ation have a low volatility is common feature in New-Keynesian models with price and/or wage rigidities [START_REF] Dib | Dynamic E¤ects of the U.S. Dollar Fluctuations in a Small Open Oil Exporting Economy: The Case of Algeria[END_REF]).

Columns 4 and 5 report the cross-correlation for our key variables. The results show that the correlation is positive between GDP and consumption, oil price and oil output in both BVAR and Baseline models. The remaining variables, such as exchange rate, in ‡ation, and international interest rate are negatively correlated with real GDP.

Globally, the Baseline model succeeded well in reproducing the results obtained by the BVAR model.

Variance decomposition Our previous …ndings are con…rmed by the variance decomposition: Algeria is especially sensitive to real shocks. Thus, technology shocks in both oil and non-oil sectors are the predominant source of macroeconomic ‡uctuations. This is common feature in New-Keynesian models, in which the main source of business cycle ‡uctuation is technology shocks. For instance, oil production shocks account for 56:21 percent of the variation in the GDP and 31:54 percent of the variation in the consumption. Non-oil production shocks explain 10:86 percent and 11:66 of the variance of GDP and consumption respectively.

Welfare e¤ects

In this section we calculate the welfare cost of external shocks under alternative monetary policy rules. We compute the welfare cost using the unconditional expectation of the utility function. After estimating the model, we simulate it by using the posteriors of the parameters. Then, we varying parameters in the monetary policy rule, while keeping all other as in the benchmark model to examine the changes in welfare under each monetary policy rule. For doing so, we use a second order approximation of the utility function around the deterministic steady state 13 . Formally, the welfare criterion is derived from the following single-period utility function:

E 0 1 X t=0 t U (c t ; h t ) ; (51)
the second order approximation result is given by:

(:) ' + c 1 E(b c t ) h 1+ E b h t (52) 2 c 1 E var (b c t ) + h E (b c t ) 2 i 2 h 1+ E var b h t + E b h t 2
where bars denote steady-state values and hats represent percentage deviations from the steady-state.

The welfare cost associated with each scenario is measured by the compensating variation which allows us to measure the percentage change in consumption in the deterministic steady state. Our main …ndings are summarized in Table 6: reports that the welfare increases after external shocks for all monetary policy rules. Nevertheless, welfare gains are di¤erent depending on the monetary policy rule adopted. The results are listed for three scenarios: i) the baseline model under ER rule;

ii) the baseline model under IT rule, and; iii) the baseline model under CIT rule. In each case, we simulate the model with all shocks, and then only one shock.

Our results show that an increase in oil price leads to a high welfare compared to the other external shocks, namely, EUR/USD, international interest rate, and world in ‡ation shocks. This is due to the fact that consumption of the Algerian households is highly dependent on oil revenues. However, the welfare gain associated with CIT rule is much greater than in the case of the other two monetary policy rules. Indeed, after an oil price shock, the CIT rule causes welfare to increase by 4:6850 percent compared to 3:4000 and 1:4187 percent respectively in the case of ER and IT rules. This is the case when the economy experiences an EUR/USD shock.

Overall, we can conclude that in the case of CIT rule, the welfare gain is quite large relatively to ER and IT rules, except in the case of international interest rate and the world in ‡ation shocks. These shocks have a low impact on the Algerian economy as shown in the variance decomposition and IRFs. This leads us to conclude that the choice of core in ‡ation rule is better than headline in ‡ation targeting and exchange rate rules.

Conclusion

In this paper, we estimated a multisector DSGE model for an oil exporting economy based on the features of the Algerian economy. To our knowledge, it's one of the …rst papers using DSGE model dedicated to this country. Building a three sectors model, we attempted to compare the response of some selected variables to external shocks and to evaluate three alternative monetary policy rules for Algerian economy. We try to shed some light to the following question: given the vulnerability of an oil exporting economy to external shocks, what is the appropriate monetary policy rule for Algerian economy?

In a …rst step, we analyzed our results from our baseline model by focusing on posterior means and impulse response functions. In a second step, we compared di¤erent monetary rules. The welfare cost associated with each monetary policy rule has been considered.

Our main …ndings show that, over the period 1990Q1-2010Q4, core in ‡ation target is the best monetary rule to stabilize both output and in ‡ation. This rule also appears to be the best way to improve social welfare. In other words, the current monetary policy -corresponding to our baseline model-followed by the Algerian central bank is not wellsuited to face to oil shocks. These results are two main policy implications. Firstly, they suggest that Algeria should modify its monetary policy in order to adopt a core in ‡ation targeting framework. This implies to ful…ll some preconditions such as the central bank independence. Secondly, Algerian authorities must strengthen the in ‡uence of interest rate as a transmission channel of the monetary policy. To this end, they must promote banking lending to the private sector and the development of the capital market. On these two points, Algeria lags relative to other upper middle income countries, especially in MENA region, preventing the use of the interest rate as the main instrument of the monetary policy.

The main drawback of this paper is the absence of …scal policy in our model. Indeed, as in some primary commodity countries, such as Chile, Algeria has established in 2000 an hydrocarbon stabilization fund (Fonds de régulation des recettes). One of the targets of this fund is to reduce the sensitivity of the …scal policy to hydrocarbon revenues ‡uctuations. Indeed, public spending tend to go hand in hand with oil receipts, generating an unstable …scal policy stance. The integration of …scal policy, and its interaction with monetary policy, in our model is the main avenue for future research.

A Impulse response functions

(

  2007), Fernández-Villaverde (2010) and Del Negro and Schorfheide (2008, 2010).

  The subjective discount factor, , is set at 0; 99 which implies an annual steady state real interest rate of 4%. As inBouakez et al. (2008) and Dib (2008a) the curvature parameter in the utility function, , is set at 2 implying an elasticity of intertemporal substitution of consumption of 0:5. Following Devereux et al. (2006) among others, the inverse of the elasticity of the intertemporal substitution of labor, , is set at 1. The capital depreciation rate, , is set at 0; 025. This value is common to the two sectors of production (oil and non-oil sectors).

  Whatever the indicator of …nancial openness -the de jure Chinn and Ito's index or the de facto Lane and Milesi-Ferretti's estimate-it appears that the Algerian economy is among the least open one. Recall that the dinar remains inconvertible for capital transactions. In 2008, according to the Chinn and Ito's index, Algeria has been ranked at the 113th position over 182 countries in terms of …nancial openness 12 . As suggested by the responses of domestic variables to the foreign in ‡ation shock, the Algerian economy seems very few sensitive to external nominal foreign disturbances. The prevalence of real external shocks relative to nominal ones has important implications to assess the choice of the right monetary policy rule. Such a rule must favor both the stabilization of the in ‡ation rate and the low volatility of production. In this perspective, a strict in ‡ation targeting framework -in which the central bank targets only the deviation of the CPI in ‡ation rate relative to its steady state equilibrium-may lead to excessive volatility of real macroeconomic variables (see the pioneer work by[START_REF] Svensson | Open Economy In ‡ation Targeting[END_REF]

  explain only a small share of the variance decomposition of our domestic variables. The low …nancial openness of Algeria explains this result. Similarly, the low degree of …nancial development explains the weak in ‡uence of domestic interest rate shocks, except for total in ‡ation. More precisely, the main instrument used by the Algerian central bank is not the interest rate -despite the introduction of open market operations in 1996-but the control of banking liquidity. To this end, the central bank continues to use indirect instruments such as reserve requirements and credit auctions.

A. 1 A. 2 A. 3 A. 4

 1234 Responses to multiple shocks (Baseline model): The e¤ect of 1% positive oil price shock: The e¤ect of 1% positive EUR/USD shock: The e¤ect of 1% positive international interest rate shock:

  technology, A o;t ;capital, k o;t , labor, h o;t , and oil factor, O t , for the crude oil production.

	Firms seeking to maximize pro…t should solve the following maximization problem:
	max ko;t;ho;t;Ot	h	e t P f o;t Y o;t Q o;t k o;t W o;t h o;t P O;t O t	i	;	(17)
	where e t P f o;t Y o;t is an oil producer's revenues in terms of domestic currency.
	To resolve (17), …rms must consider their function of production given by the follow-
	ing Cobb-Douglas technology:
			Y o;t A o;t k o o;t h o o;t O o t ;			(18)
	where o ; o and o 2 (0; 1) and o + o + o = 1: These coe¢ cients denote respectively shares of capital, k o;t , labor, h o;t and oil resource, O t , in the production of oil.
	Thus, given e t ; P f o;t ; Q o;t ; W
	Oil output is totally exported abroad at the international price P f o;t denominated in the
	US dollar.

o;t and P O;t ;the oil producing …rm chooses {k o;t ;h o;t ;O t } to maximize (17) subject to

  Ao;t are uncorrelated and normally distributed innovations with zero mean and standard deviations P f

) log(A o;t ) = (1 Ao ) log(A o ) + Ao log(A o;t 1 ) + " Ao;t ; (24) where P f o , O and A o are steady state values of P f o;t , O t and A o;t . P f o ; O and Ao are the autocorrelation coe¢ cients, and " P f o ;t , " O;t and " o ; O and Ao respectively.

  Note …nally that the …nal good is divided between total consumption and total investment so that z t = c t + i o;t + i no;t :

	Y I;t = I	P I;t P t		z t ; and Y no;t = no	P no;t P t	z t ;	(43)
	where P t ; P I;t ; P no;t are given. Note also that the zero pro…t condition implies that
	the price of …nal good is given by:
			P t =	h	I P 1 I;t + no P 1 no;t	i 1 1	:	(44)
	2.6 Monetary policy
	(1 + R t+1 ) 1 + R	=	P no;t P no;t 1	1 no	no	P t P t 1	1	e t e
	Resolving this problem, we get the following demand function:

chooses fY I;t and Y no;t g : We assume that the central bank adjusts the short-term nominal interest rate, i t , in response to ‡uctuation in in ‡ation in the non-oil goods sector (core in ‡ation), no;t , CPI in ‡ation, t , and exchange rate, e t according to the following Taylor-type monetary policy rule: e exp(" R ); (45) where R; no ; ; and e are the steady state values of R t ; no;t ; t ;and e t : The policy coe¢ cient, no ; ;and e measuring central bank response to deviation of no;t ; t ;and e t from their steady state levels. When the central bank adopts a CPI in ‡ation targeting regime (IT rule), no = e = 0 and ! 1: In this case, the central bank only responds to in ‡ation movement. When = e = 0 and no ! 1; the central bank controls the in ‡ation rate in the nonoil goods sector (CIT rule): Finally, when = no = 0 and e ! 1; the central bank strictly target the nominal exchange rate (ER rule):The serially uncorrelated monetary policy shock, " R , is normally distributed with zero mean and standard deviation R .

  ) in the oil sector and the amount of oil's subsidies s t t p f

	o;t	p o;t Y I o;t .

j=o;T;nT W j;t h j;t + s t p f o;t Y o;t = s t t p f o;t p o;t Y I o;t + w o;t h o;t + q o;t k o;t ; (47) where the left hand side represents the government's revenue that includes a lumpsum tax, $, and receipts from selling oil s t p f o;t Y o;t . The right hand side represents the government spending that include payment both wages and capital return (w o;t h o;t + q o;t k o;t

  I;t , Y t , z t , k o;t , k no;t , h t , h o;t , h no;t , b f t , t } 1 t=0 and a sequence of prices and co-state variables {w o;t , w no;t , q o;t , q no;t , p o;t , p no;t , e p no;t , e p I;t , p I;t , p O;t , t , no;t , I;t , s t , e t , R t , t , mc no;t , mc I;t } 1 t=0 satisfying household, oil and non-oil …rst order conditions, the aggregate resources constraints, the monetary policy rules, the current account equation and the stochastic processes {A o;t ;A no;t ;p f o;t , O t , t , R f t , f t } 1 t=0 of the shocks and the following market clearing conditions b t =b t 1 =0,

	Y t = p no;t Y va no;t + s t p f o;t Y o;t ;	(48)
	where Y t ; and Y va no;t are the aggregate GDP and value-added output in non-oil goods
	sector respectively. The variable, Y va no;t , is constructed by subtracting oil input as follow 8 :
	Y va no;t = Y no;t s t p f o;t	Y T o;t p no;t	;
	b f t = e b f t and:

e p no;t (i)=e p no;t , Y I;t (i)=Y I;t , e p I;t (i)=e p I;t for all i 2 (0; 1) :Thus, a symmetric equilibrium for this economy is composed of an allocation {c t , i t , i o;t , i no;t , Y o;t , Y no;t , Y va no;t , Y I o;t , Y

Table 1 :

 1 Calibration of structural parameters

	Description

reliable estimations from other sources; and (iii) those whose values are crucial to replicate the main steady-state key ratios of the Algerian economy

9

. Table

1

reports the calibration values.

  share of capital, no , labor, no , and a fraction of oil output, no ;in the production

	R f	s.d inter-interest rate	R +	InvGamma	0:5	inf
	ao	s.d oil produc	R +	InvGamma	0:5	inf
	ano	s.d non-oil produc	R +	InvGamma	0:5	inf
		f	s.d world in ‡ation	R +	InvGamma	0:5	inf
	p	f o	s.d oil price	R +	InvGamma	0:5	inf
	O	s.d oil resource	R +	InvGamma	0:5	inf
	of non-oil goods. The standard deviations of these parameters are assumed to follow s.d EURO/USD R + InvGamma 0:5	inf
	Beta distribution and a standard error of 0:05.

Table 3

 3

reports the bayesian estimation results of the structural parameters of the baseline model. As in several econometric studies of DSGE models, we estimate the model by computing the posterior mode and constructing the posterior distribution with the Metropolis-Hastings algorithm by generating 100.000 draws. Recall that prior means are mainly based on previous studies dedicated to oil exporters economies since few studies consider the case of Algeria.

  sum up, we see that the exchange rate rule is especially ine¢ cient to respond to oil price shocks. Indeed, this rule implies a too reactive interest rate reaction to any exchange rate deviation from its equilibrium state. Such reaction leads to a high volatility of macroeconomic variables. Our results suggest at the same time that exchange rate rule is unable to stabilize in ‡ation. From this perspective, if we consider the trade-o¤ macroeconomic stabilization-low in ‡ation environment, we …nd that the core-in ‡ation targeting rule is superior to the in ‡ation targeting rule. Our results are in line with the recent literature on monetary policy in small open economies[START_REF] Parrado | In ‡ation Targeting and Exchange Rate Rules in an Open Economy[END_REF]; Medina and Soto (2005) and Dhawan and Jeske (2007)). In the case of Algeria, targeting core-in ‡ation instead of headline in ‡ation allows to avoid the potential monetary policy overreaction due to oil prices ‡uctuations. Recall that this shock is one of the main a¤ecting Algerian economy (see Table3.b).E¤ects of EUR/USD exchange rate shock In the case of exchange rate shock, all contemporaneous responses but one (the real exchange rate) are weaker under the CIT rule. At the same time, this monetary policy rule allows the smoother adjustment after the shock. Interestingly, both the baseline model and the exchange rate rule lead to higher macroeconomic volatility. More precisely, Figure A.3 shows that real variables such as GDP, consumption, investment, oil and non-oil production, and the current account) have stronger short-run responses relatively to the core in ‡ation targeting. This result suggests that the central bank overreacts if the exchange rate is targeted (as in the case of exchange rate rule) or if it targets both oil price and exchange rate (in the case of our baseline model). The exchange rate rule is especially e¤ective to stabilize the real exchange rate in the aftermath of the shock. However, when assessing the pro and cons of alternative monetary rules, this e¤ectiveness must not be overestimated, for two main reasons. Firstly, as exhibited in Figure A.3, the responses of the real exchange rate are short-lived whatever the monetary rule. Secondly, as we stressed above, the Algerian foreign exchange market is very thin. The central bank is the sole seller of foreign exchange. More precisely, the central bank accumulates foreign exchange reserves by bene…cing from the revenues due to hydrocarbon exports. Foreign exchange reserves are the main instrument used by the authorities to monitor the dinar exchange rate. In other words, the nominal interest rate is not constrained by the exchange rate target.

Table 4 :

 4 Table 4 reports the results of the DSGE model and the BVAR model. The standard deviations are expressed in percentage terms. Volatility and correlation

	Variables	Volatility		Correlation with GDP
		VAR model	DSGE model	VAR model	DSGE model
	Y	0:20	0:2570
	c	0:569	0:4515	0:1283	0:7352
	Y o	0:303	0:2958	0:8129	0:8860
		0:035	0:0435	0:1602	0:1831
	P f o	0:758	0:1864	0:7585	0:0379
	R f	0:463	0:5479	0:5418	0:1530
	s	0:332	0:4142	0:8316	0:7538

Table 5 :

 5 variance decomposition.

		" R f	" p f o	" f	"	" ao	" ano	" o	" R
	Y t	4.65 6.41 0.14 1.33 56.21 10.86 19.30 1.11
	c t	1.71 42.62 0.40 2.83 31.54 11.66 6.09 3.14
	i t	1.79 36.36 0.57 2.18 18.95 29.91 5.78 4.46
	Y o;t 5.96 9.04 0.06 2.51 76.34 4.70	0.91 0.48
	Y no;t 3.32 4.39 0.09 1.30 28.02 52.11 10.07 0.71
	t	2.12 9.21 0.77 0.80 40.34 34.11 6.59 6.06
	no;t	2.39 6.37 0.15 0.91 43.65 38.03 7.35 1.16
	q o;t 0.43 14.55 0.13 0.88 72.98 8.41	1.63 0.99
	q no;t 0.52 15.07 0.19 0.86 9.96 69.96 1.92 1.51
	Interestingly, prices and monetary shocks tend to exert a weaker in ‡uence on macro-
	economic variables. For instance, international interest rate and foreign in ‡ation shocks

Table 6 :

 6 Welfare results (in % of the steady state of consumption)

		Oil price EUR/USD	IIR	World in ‡ation All shocks
	Monetary policy rules
	ER rule	3:4000	0:6042	0:2883	0:8869	4:7510
	IT rule	1:4187	0:6110	0:4855	0:2183	4:6051
	CIT rule	4:6850	0:6754	0:3459	0:1233	4:0779
	Table

If we consider the Middle East & North Africa (MENA) region as a whole, the exports of goods and services in percentage of GDP amounted to 41.4 in

while the trade openness was 79.2 percent during the same year.[START_REF] Benkhodja | Monetary Policy and the Dutch Disease in a Small Open Oil Exporting Economy[END_REF] For a sample included Egypt, Jordan, Kuwait, Lebanon, Libya, Morrocco, Oman, Qatar, Saudi Arabia, Tunisia, and United Arab Emirates. Data are extracted from IMF, World Economic Outlook Database, September 2011.[START_REF] Bernanke | Systematic Monetary Policy and the E¤ects of Oil Price Shocks[END_REF] IMF World Economic Outlook Database, September 2011.

As in[START_REF] Dib | Dynamic E¤ects of the U.S. Dollar Fluctuations in a Small Open Oil Exporting Economy: The Case of Algeria[END_REF], we consider the euro as an invoicing currency of a part of imports.

If the domestic economy is a net lender households receive a lower remuneration on their saving. If the economy is a net lender, households charge a premium on the foreign interest rate.

See Schmitt-Grohé and Uribe (2003) for alternative ways of ensuring stationary paths in small open economy.

It's the case of Algeria and other countries as Iran.

As inDib (2008a and b), our model supposes that non-oil …rms use re…ned oil as material inputs in their productions which is de…ned as gross output. Thus, value added output in each sector can be constructed by substracting commodity inputs.

To compute the Algerian economy steady state ratios, we use annual data, over the period 1990-2010.

0 According to the World Trade Organization trade pro…les, in

2009, agricultural products and manufactures account for 17.8% and 79.7% of total imports respectively.1 1 Using the Reinhart and Rogo¤'s classi…cation. According to the IMF, Algeria in classi…ed in the category "other managed arrangement with no preannounced path for the exchange rate". See IMF

[START_REF] Benkhodja | Monetary Policy and the Dutch Disease in a Small Open Oil Exporting Economy[END_REF] The de facto measure gives a similar picture. In

2007, the volume-based measure of …nancial integration -that is the sum of the stock of foreign assets and liabilities divided by the GDP-was 104.1 per cent for Algeria against 182.1 percent for emerging countries. Authors' calculations using the updated and extended version of the External wealth of nations, Mark II database developed by Lane and Milesi-Ferretti (2007).

[START_REF] Bernanke | Systematic Monetary Policy and the E¤ects of Oil Price Shocks[END_REF] For similar method see Schmitt-Grohé and Uribe(2007)

The lower part of Table 3.a exhibits the monetary policy coe¢ cients. Our baseline model suggests that the exchange rate does not play a major role in the monetary policy decisions. Indeed, we see that the posterior mean related to the parameter e is signi…cantly below prior mean, 0:035 and 0:70 respectively.

As in Dib (2008a and b), we assumed that the parameter representing the degree of monopoly power in the intermediate good market, #, is equal to 6. In other words, at the steady state the price-markup is 20 percent. Our posterior mean is close to the prior value and its value is equal to 4:03.

The share of imported goods (0:625) in the …nal good is greater than the non-oil

Import inflation

Baseline ER rule IT rule CIT rule

B Data description

In this paper we used Algerian data obtained from IMF-IFS and ONS (National O¢ ce of Statistics). The common period covered by all series is 1990:Q1-2010:Q4.

Oil production is measured by crude petroleum production, IMF-IFS database.

Domestic in ‡ation is measured by the percentage change in the consumer price index. The CPI is obtained from IMF-IFS database and ONS. Domestic interest rate is the nominal discount rate of the bank of Algeria, IMF-IFS database.

USD/DZD real exchange rate is constructed by multiplying the bilateral nominal exchange rate, de…ned as the price of one U.S dollar in terms of Algerian dinar, by the ratio of the U.S consumer price index (CPI) to the Algerian CPI, IMF-IFS database. Domestic Output is the Gross Domestic Product. In the IMF-IFS database, the GDP serie is published in annual frequency. We transformed it into quarterly frequency.

The GDP is also seasonally adjusted by using X-11 procedure.

Consumption is measured by the household expenditure. As in the case of real GDP, the consumption serie was transformed into quarterly data, IMF-IFS database.

International oil price is the world nominal oil price, it comes from IMF primary commodity prices database.