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This paper considers monetary and fiscal policy responses to oil price shocks in low income oil importing countries. The author examines the dynamic properties and the welfare implications of a set of inflation targeting policies and a group of policies where the government provides a subsidy on household purchases of oil products and finances this subsidy through some combination of printing money and raising non-distortionary lump sum taxes. Even in the case where lump sum taxes finance the subsidy, it distorts household behavior in important ways leading to over consumption of oil products, increased trade deficits, and distortions to the labor supply.
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