The Macroeconomics of Energy Price Shocks and Electricity Market Reforms:The Case of Bangladesh

Abstract

Electricity is a vital instrument for economic growth and human development. The measure of growth in developing countries like Bangladesh is synonymous with the level of electricity use. Energy (oil) price shocks are often identified as a source of macroeconomic fluctuations since they affect economic development as well as business cycle. Accordingly, it has been argued that electricity market reforms are a possible tool to improve economic performance, efficiency, welfare and overall economic development. The Bangladesh economy is vulnerable to energy (oil) price shocks and the government has adopted different electricity reform policies in the past few years. However, there is a real gap in the energy literature with regard to the qualitative and quantitative analysis of the consequences of energy (oil) price shocks and electricity market reforms towards the Bangladesh economy.
This thesis is divided into two main parts. The first part contains two chapters titled, “A Survey of Literature” and “Energy Scenario in Bangladesh” which extensively review the related literature and underline the research gaps that this thesis intends to address. The second part of this thesis includes three novel papers in the literature on energy (oil) prices, electricity market reforms and the macro economy, all applied to the case of Bangladesh: “Energy Price Shocks and Real Business Cycle”, “A DSGE Analysis of Oil Price Shocks” and “A DSGE Analysis of the Welfare Effects of Alternative Electricity Pricing Schemes”. The following research questions are addressed:
1. How important aggregate energy price shocks are to explain business cycle fluctuations for the Bangladesh economy?
2. How would oil price shocks affect the macro economy of a small, oil importing, developing country like Bangladesh?
3. How would electricity market reforms affect the Bangladesh Economy?
To answer these questions we develop a Real Business Cycle (RBC) model and a Dynamic Stochastic General Equilibrium (DSGE) model for Bangladesh, the latter including a detailed model of the energy (electricity) sector which has not been attempted before in the literature. We conclude that the RBC model does a reasonable job in capturing the qualitative changes of selected endogenous variables considering the energy and productivity shocks. We find that oil price shocks have a negative welfare effect on consumers and GDP. However, industry expands to produce more exportable goods as higher oil price makes the country worse off with regard to Terms of Trade (TOT). Lower wage and capital interest rate allow industry to employ more labour and capital and increase production. Our results also reveal that electricity reform policies (restructuring of prices and subsidy arrangements) increase household welfare and GDP in Bangladesh. Given our results, it is advisable that policymakers carefully assess the overall welfare effect of oil price shocks and electricity market reforms and when appropriate take some measures to redistribute welfare across sectors. The heterogeneity nature of the households would be more appropriate for policy analysis and the analysis of these redistribution policies is left for future research. As some other developing countries face the same issues as Bangladesh, the novel framework and results of this thesis are of relevance not only for Bangladesh but also for developing countries in general.