Question

“The global supply of oil might be about to shrink, and prices rise. Saudi Arabia’s Energy Minister announced on Nov. 11 the kingdom would cut its oil production by 1,500,000 barrels per day in December. In the same month, the 15 nations that make up OPEC will likely confirm a coordinated move to push prices higher. Add the imposition of U.S. sanctions on Iran’s oil exports that came into force on Nov. 5, lower production in crisis-plagued Venezuela and the risk that unrest may lower production in places like Libya and Nigeria, and oil could be set for a rebound.” Note this paragraph is taken from a Risk Report on Time magazine. Please see attached scanned article, or read it online at http://time.com/5455485/mohammed-bin-salman-image/ . The only difference in this scenario is the 500,000 barrels has gone to 1.5 million barrels.

It’s January 2019. Unemployment is still less than 4 percent. Fed increased the federal funds rate target in December 2017 to 2.25-2.50 % and announced more rounds of interest rate increases in 2019. The national debt has crippled to $21.6 trillion.

You are an adviser to the White House. The President asks you to do a report about the impact of Saudi Arabia and rest of the countries’ decision on US (what exactly has happened, why everybody is complaining), and what measures could be taken, including monetary and/or fiscal policies. In the end of the memo, the President has written in handwriting: “Please include advantages and disadvantages of all possible options . Your advice is appreciated.”

Note: Although many decisions depend on politics, I expect the focus of your answers to be mainly on the economic aspects.

Answer 1

Since OPEC mnembers including saudi arabia and Iran are cutting down production this will increase crude oil prices substantially and as result dollar will get appreciated against other currencies because crude oil is pegged with US dollars and its demand shall increase thereby.

An appreciation of dollar means more imports and hence inflation is set to rise in USA and trade deficit too shall increase. Prices of basic commodities will rise too.

Hence US Fed should adopt contractionary monetary policy to avert the inflation in near term. Also domestic manufacturibg of crude oil should be promoted to reduce import bill.

Advantages :

• Reduces inflation and keeps prices steady
• Helps focus on higher domestic production of crude oil
• Creates more employment opportunities
• Better forex reserves

Disadvantage :

• Increases wage rates because of better demand
• Decreasing ties and relationships with OPEC members
• Money supply can be reduced and infrastructure can take hit