Decomposing the links between oil price shocks and macroeconomic indicators: Evidence from SAARC region

Ahmed, Khalid and Bhutto, Niaz Ahmed and Kalhoro, Muhammad Ramzan (2017): Decomposing the links between oil price shocks and macroeconomic indicators: Evidence from SAARC region.

Abstract

This study examines the impact of oil price shocks on key macroeconomic variables (i.e., real GDP, interest rate, inflation and exchange rate) for five SAARC countries (i.e., India, Pakistan, Bangladesh, Sri Lanka and Bhutan). For this purpose, we adopt contemporary macroeconomic policy modeling tool called impulse response function (IRF) and forecast error variance decomposition method (FEVDM) in the structural vector autorepression (SVAR) setting using time series data over the extended period from 1982 to 2014. In addition, Johansen and Juselius (1990) cointegration method is applied for long-run relationship. The results of cointegration test confirms the long-run equilibrium relationship between all the underlying variables. However, the empirical findings of IRF explained significant variation among all underlying macroeconomic variables in response to exogenous oil price shocks at different time horizons. It means the macroeconomic factors are sensitive to even small oil price shocks and possess various socio-economic implications in the region. The results of FEVDM evidence that each country in a study group responds differently to oil price shocks, it corresponds their independent policies, macroeconomic fundamentals, sector constructions and heterogeneity across the countries. The findings help governments to reform public policies in the region by controlling macroeconomic fluctuations due to oil price shocks.

• Item Type: MPRA Paper
• Language: English
• Keywords: Oil price shocks; Interest rate; GDP; SAARC; SVAR model
• Subjects: E - Macroeconomics and Monetary Economics > E2 - Consumption, Saving, Production, Investment, Labor Markets, and Informal Economy; E - Macroeconomics and Monetary Economics > E2 - Consumption, Saving, Production, Investment, Labor Markets, and Informal Economy > E20 - General; E - Macroeconomics and Monetary Economics > E4 - Money and Interest Rates; E - Macroeconomics and Monetary Economics > E6 - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook > E64 - Incomes Policy ; Price Policy; O - Economic Development, Innovation, Technological Change, and Growth > O4 - Economic Growth and Aggregate Productivity

References

Abeysinghe, T. (2001). Estimation of direct and indirect impact of oil price on growth. Economics letters, 73(2), 147-153.

Amano, R. A., & Van Norden, S. (1998). Oil prices and the rise and fall of the US real exchange rate. Journal of international Money and finance, 17(2), 299-316.

Basnet, H. C., & Upadhyaya, K. P. (2015). Impact of oil price shocks on output, inflation and the real exchange rate: evidence from selected ASEAN countries. Applied Economics, 47(29), 3078-3091.

Bernanke, B. S. (1983). Non-monetary effects of the financial crisis in the propagation of the Great Depression: National Bureau of Economic Research Cambridge, Mass., USA.

Bernanke, B. S., Gertler, M., Watson, M., Sims, C. A., & Friedman, B. M. (1997). Systematic monetary policy and the effects of oil price shocks. Brookings papers on economic activity, 1997(1), 91-157.

Bohi, D. R. (1989). Energy price shocks and macroeconomic performance: Resources for the Future.

BP Statistical Review of World Energy (2012). [Press release]. Retrieved from http://www.bp.com/en_no/norway/media/press-releases-and-news/2012/bp-statistical-review-of-world-energy-2012.html

Burbidge, J., & Harrison, A. (1984). Testing for the effects of oil-price rises using vector autoregressions. International Economic Review, 459-484.

Christiano, L., Motto, R., & Rostagno, M. (2007). Financial factors in business cycles.

Clarida, R., Gali, J., & Gertler, M. (1997). Monetary policy rules and macroeconomic stability: Evidence and some theory.

Cunado, J., & De Gracia, F. P. (2005). Oil prices, economic activity and inflation: evidence for some Asian countries. The Time horizonly Review of Economics and Finance, 45(1), 65-83.

Cunado, J., Jo, S., & de Gracia, F. P. (2015). Macroeconomic impacts of oil price shocks in Asian economies. Energy Policy, 86, 867-879.

Darby, M. R. (1982). The price of oil and world inflation and recession. The American Economic Review, 72(4), 738-751.

Darrat*, A. F., & Al-Shamsi, F. S. (2005). On the path of integration in the Gulf region. Applied Economics, 37(9), 1055-1062.

DEPARTMENT, I. E. R. (2012). New Perspectives on Asia's Role in the Global Economy. from https://www.imf.org/external/np/speeches/2012/071212a.htm

Dickey, D. A., & Fuller, W. A. (1979). Distribution of the estimators for autoregressive time series with a unit root. Journal of the American statistical association, 74(366a), 427-431.

Edelstein, P., & Kilian, L. (2009). How sensitive are consumer expenditures to retail energy prices? Journal of Monetary Economics, 56(6), 766-779.

Eichengreen, B. (2008). China, Asia, and the new world economy: Oxford University Press on Demand.

Enders, W. (2004). Applied Econometric Time Series, by Walter. Technometrics, 46(2), 264.

Ghosh, S. (2011). Examining crude oil price–Exchange rate nexus for India during the period of extreme oil price volatility. Applied Energy, 88(5), 1886-1889.

Gisser, M., & Goodwin, T. H. (1986). Crude oil and the macroeconomy: Tests of some popular notions: Note. Journal of Money, Credit and Banking, 18(1), 95-103.

Global Energy Year Book (2017). https://yearbook.enerdata.net/ (Accessed on 22.02.2018)

Hamilton, J. D. (1983). Oil and the macroeconomy since World War II. The Journal of Political Economy, 228-248.

Hamilton, J. D. (1996). This is what happened to the oil price-macroeconomy relationship. Journal of Monetary Economics, 38(2), 215-220.

Huntington, H. G. (2005). The Economic Consequences of Higher Crude Oil Prices

Issa, R., Lafrance, R., & Murray, J. (2008). The turning black tide: energy prices and the Canadian dollar. Canadian Journal of Economics/Revue canadienne d'économique, 41(3), 737-759.

Iwayemi, A., & Fowowe, B. (2011). Impact of oil price shocks on selected macroeconomic in Nigeria. Energy policy, 39(2), 603-612.

Johansen, S., & Juselius, K. (1990). Maximum likelihood estimation and inference on cointegration—with applications to the demand for money. Oxford Bulletin of Economics and statistics, 52(2), 169-210.

Khan, M. A., & Ahmed, A. (2011). Macroeconomic effects of global food and oil price shocks to the Pakistan economy: a structural vector autoregressive (SVAR) analysis. The Pakistan Development Review, 491-511.

Kilian, L., & Park, C. (2009). The impact of oil price shocks on the US stock market. International Economic Review, 50(4), 1267-1287.

Kim, K. S. (2005). Impacts of Foreign Shocks onDomestic Macroeconomic Fluctuations Policy References 05-06.

Kim, S., & Roubini, N. (2000). Exchange rate anomalies in the industrial countries: A solution with a structural VAR approach. Journal of Monetary Economics, 45(3), 561-586.

Leduc, S., & Sill, K. (2004). A quantitative analysis of oil-price shocks, systematic monetary policy, and economic downturns. Journal of Monetary Economics, 51(4), 781-808.

Lee, K., Ni, S., & Ratti, R. A. (1995). Oil shocks and the macroeconomy: the role of price variability. The Energy Journal, 39-56.

Lescaroux, F., & Mignon, V. (2008). On the influence of oil prices on economic activity and other macroeconomic and financial variables. OPEC Energy Review, 32(4), 343-380.

MICHAEL, A. (2013). Sovereignty vs. Security: SAARC and its Role in the Regional Security Architecture in South Asia. Harvard Asia Time horizonly, Vol. XV, No. 2.

Mork, K. A. (1989). Oil and the macroeconomy when prices go up and down: an extension of Hamilton's results. Journal of political Economy, 97(3), 740-744.

Mork, K. A., & Hall, R. E. (1980). Energy Prices and the US Economy in 1979-1981. The Energy Journal, 1(2), 41-53.

Narayan, P. K., Sharma, S., Poon, W. C., & Westerlund, J. (2014). Do oil prices predict economic growth? New global evidence. Energy Economics, 41, 137-146.

Park, C., Chung, M., & Lee, S. (2011). The effects of oil price on regional economies with different production structures: A case study from Korea using a structural VAR model. Energy Policy, 39(12), 8185-8195.

Peersman, G. (2005). What caused the early millennium slowdown? Evidence based on vector autoregressions. Journal of Applied Econometrics, 20(2), 185-207.

Peersman, G., & Van Robays, I. (2009). Oil and the Euro area economy. Economic Policy, 24(60), 603-651.

Phillips, P. C., & Perron, P. (1988). Testing for a unit root in time series regression. Biometrika, 75(2), 335-346.

Pierce, J. L., Enzler, J. J., Fand, D. I., & Gordon, R. (1974). The effects of external inflationary shocks. Brookings papers on economic activity, 1974(1), 13-61.

Rasche, R. H., & Tatom, J. A. (1977). The effects of the new energy regime on economic capacity, production, and prices. Review.

Raza, N., Shahzad, S. J. H., Tiwari, A. K., & Shahbaz, M. (2016). Asymmetric impact of gold, oil prices and their volatilities on stock prices of emerging markets. Resources Policy, 49, 290-301.

Richard, J. C., & Michael, F. (1980). OIL IMPORTS AND INFLATION: AN EMPIRICAL INTERNATIONAL ANALYSIS OF THE ‘IMPORTED’INFLATION THESIS. Kyklos, 33(4), 615-622.

Secretariat, S. (2010). SAARC Regional Energy Trade Study (SRETS).

Shahbaz, M., Naeem, M., Ahad, M., & Tahir, I. (2017). Is natural resource abundance a stimulus for financial development in the USA?. Resources Policy.

Sill, K. (2007). The macroeconomics of oil shocks. Federal Reserve Bank of Philadelphia, Business Review, 1(1), 21-31.

Tatom, J. A. (1988). Are the macroeconomic effects of oil-price changes symmetric? Paper presented at the Carnegie-Rochester Conference Series on Public Policy.

Timilsina, G. R. (2015). Oil prices and the global economy: A general equilibrium analysis. Energy Economics, 49, 669-675.