Oil Price Shocks and Macroeconomy: The Role for Precautionary Demand and Storage

Rizvanoghlu, Islam (2011): Oil Price Shocks and Macroeconomy: The Role for Precautionary Demand and Storage.

Abstract

Traditional literature on energy economics gives a central role to exogenous political events (supply shocks) or to global economic growth (aggregate demand shock) in modeling the oil market. However, more recent literature claims that the increased precautionary demand for oil triggered by increased uncertainty about a future oil supply shortfall is also driving the price of oil. The intuition behind the precautionary demand is that since firms, using oil as an input in their production process, are concerned about the future oil prices, it is reasonable to think that in the case of uncertainty about future oil supply (such as a highly expected war in the Middle East), they will buy futures and/or forward contracts to guarantee a future price and quantity. We find that under baseline Taylor-type interest rate rule, real oil price, inflation and output loss overshoot and go down below steady state at the next period if uncertainties are not realized. However, if the shock is realized, i.e. followed by an actual supply shock, the effect on inflation and output loss is high and persistent.

• Item Type: MPRA Paper
• Language: English
• Keywords: oil price shocks; precautionary demand; storage
• Subjects: E - Macroeconomics and Monetary Economics > E3 - Prices, Business Fluctuations, and Cycles > E32 - Business Fluctuations ; Cycles; E - Macroeconomics and Monetary Economics > E5 - Monetary Policy, Central Banking, and the Supply of Money and Credit > E52 - Monetary Policy; Q - Agricultural and Natural Resource Economics ; Environmental and Ecological Economics > Q4 - Energy > Q43 - Energy and the Macroeconomy

References

Barsky, R. and Killian L., (2002), °Do We Really Know that Oil Caused the Great Stagfla- tion? A Monetary Alternative␣, NBER Macroeconomics Annual 2001, 137-183.

Benigno, G., Benigno, P., and Nistico S., (2010), °Second-Order Approximation of Dynamic Models with Time-Varying Risk␣,NBER Working Paper Series, 16633.

Benigno, P. and Woodford M. (2004), °Optimal Monetary and Fiscal Policy: A Linear Quadratic Approach␣, NBER Working Papers, 9905.

Bernanke, B.S., Gertler M., and Watson M., (1997), °Systematic Monetary Policy and the Effects of Oil Price Shocks␣, Brookings papers on Economic Activity,1, 91-157.

Blanchard, Olivier J., and Gali J., (2007a) Real Wage Rigidities and the New Keynesian Model, Journal of Money, Credit and Banking, 39, 3565.

Blanchard, J.O. and Gali J., (2007b), °The Macroeconomic Effects of Oil Shocks: Why Are the 2000s So Different from 70s␣, NBER Working paper, 13368.

Carlstrom, C.T. and Fuerst T.S., (2006), °Oil Prices, Monetary Policy, and Counterfactual Experiments␣, Journal of Money, Credit and Banking, 38(7), 1945-1958.

Campolmi, A., (2009), °Oil Price Shocks: Demand vs Supply in a Two-Country Model␣, mimeo.

Calvo, G.A., (1983), °Staggered Prices in a Utility-maximizing Framework␣, Journal of Monetary Economics, 12(3), 383-39.

Clarida, R., Gali, J., and Gertler, M. (2000), °Monetary Policy Rules and Macroeconomic Stability: Evidence and Some Theory␣The Quarterly Journal of Economics, 115(1), 147-180.

Dhawan, R. and Jeske K., (2006), °Energy Price Shocks and the Macroeconomy: The Role of Consumer Durables␣, Federal Reserve Bank of Atlanta, Working papers.

Frankel, J. (2008),°The Effect of Monetary Policy on Real Commodity Prices␣in Asset Prices and Monetary Policy, John Campbell, ed., U.Chicago Press, 291-327

Gorton G.B., Hayashi F. and Rouwenhorst K.G., (2007), °The Fundamentals of Commodity Futures Returns␣, NBER Working paper, 13249.

Hamilton, J. and Herrera A.M., (2004), °The Oil Shocks and Aggregate Macroeconomic Behavior: The Role of Monetary Policy␣, Journal of Money, Credit, and Banking, 36, 265- 286.

Khan, A., King, R.G. and Wolman, A. L., (2003), °Optimal Monetary Policy␣, Review of Economic Studies 70, 825860.

Kilian, L., (2009), °Not All Oil Price Shocks Are Alike: Disentangling Demand and Supply Shocks in the Crude Oil Market␣, American Economic Review, 99(3), 1053-1069.

Kilian, L. and Alquist R., (2010), °What do we learn from the price of crude oil futures?␣, Journal of Applied Econometrics, 25(4), 539-573.

Kim, I. and Loungani P., (1992), °The Role of Energy in Real Business Cycle Models␣, Journal of Monetary Economics, 29(2), 173-189.

Leduc, S. and Sill K., (2004), °A Quantitative Analysis of Oil Price Shocks, Systematic Monetary Policy, and Economic Downturns␣, Journal of Monetary Economics, 51(4), 781- 808.

Rotemberg, J.J., and Woodford M., (1996), °Imperfect Competition and the Effects of En- ergy Price Increase on Economic Activity␣, Journal of Money, Credit, and Banking, 28(4), 549-577.

Schmitt-Grohe, S., Uribe, M. (2004a). °Optimal Operational Monetary Policy in the Christiano- Eichenbaum-Evans Model of the U.S. Business Cycl etextacutedbl, NBER Working Papers, 10724

Unalmis, D., Unalmis, I. and Unsal D.F., (2012) °On the Sources and Consequences of Oil Price Shocks: the Role of Storage␣, Working paper.

Wei, C., (2003), °The Stock Market, and the Putty-Clay Investment Model␣, American Economic Review, 93(1), 311-323.

Woodford, M. (2003), Interest and Prices: Foundations of a Theory of Monetary Policy, Princeton: Princeton University Press.

Yun, T., (1996), °Nominal Price rigidity, Money Supply Endogeneity, and Business Cycles␣, Journal of Monetary Economics, 37(2), 345370.