How important are real interest rates for oil prices?

Arora, Vipin and Tanner, Matthew (2011): How important are real interest rates for oil prices?

Abstract

Using a recursive vector autoregression (VAR), this paper considers the relation between the U.S. real interest rate and the real oil price. Theoretically, as outlined in Hotelling (1931) and Working (1949), a lower real interest rate results in reduced production and increased storage, implying a higher oil price. The results presented here show that the robustness of this relationship depends crucially on how the real interest rate is calculated, and the time-frame of the sample. Consistent with earlier studies, the oil price falls with an innovation to the ex-ante U.S. real interest rate. However, this is not true if the real interest rate is calculated ex-post. In this case, the oil price only falls in response to an innovation in short-term U.S. real interest rates (three months or less). Additionally, the response of the oil price to longer-term ex-ante U.S. real interest rates must include the period through 2006 for this relationship to appear. The oil price consistently responds to innovations in short-term rates throughout the entire sample. We draw two conclusions from the results. The first is that the oil price is consistently responsive to short-term U.S. real interest rates, underlying the importance of storage. Second, oil prices have become more responsive to longer-term U.S. real interest rates. The reasons behind this change are unclear and require further study.

• Item Type: MPRA Paper
• Language: English
• Keywords: Oil price, Real interest rate, VAR, Hotelling, Storage
• Subjects: F - International Economics > F4 - Macroeconomic Aspects of International Trade and Finance > F49 - Other; Q - Agricultural and Natural Resource Economics ; Environmental and Ecological Economics > Q4 - Energy > Q43 - Energy and the Macroeconomy

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