Abstract
This chapter studies the effects of an increase in the price of an intermediate input on economic growth of a small open economy. Most of the analysis employs a nonscale growth model, although for comparative purposes we also briefly consider a simple endogenous growth model. The economy has access to a perfect world capital market, a consequence of which is that the equilibrium growth rates of consumption and output can diverge indefinitely. Both models imply that following an oil shock consumption level, although its subsequent growth rate remains unaffected. But the two models yield sharply contrasting implications for the growth rate of capital and ouput. The nonscale growth model implies that the effects on the growth rate are only temporary. Eventually, the growth rate of capital and output recovers back to its initial balanced growth rate, although output, capital, and consumption are all permanently lower. In the case of the endogenous growth model, there are no transitional dynamics; a permanent increase in the price of the imported input leads to a permanent constant reduction in the growth rate of capital and output.