in this group of countries also have large consequences for the rest of the world through their impact on globaloil prices. In contrast to the existing literature, we use a GVAR model including major oil exporters to disentangle the size and speed of the transmission of di¤er- ent oil-price shocks to the globaleconomy. This approach employs a dynamic multi-country framework for the analysis of the international transmission of shocks. The framework com- prises 38 country/region-speci…c models, among which is a single Euro Area region (com- prising 8 of the 11 countries that joined Euro in 1999) as well as the countries of the Gulf Cooperation Council (GCC). These individual models are solved in a global setting where core macroeconomic variables of each economy are related to corresponding foreign variables, which have been constructed to match the international trade pattern of the country under consideration. The model has both real and …nancial variables: real GDP, in‡ation, real equity prices, real e¤ective exchange rate, short and long-term interest rates, a measure of globaloil production, and the price of oil. We treat the latter endogenously as the question of whether oil prices are demand-driven or supply-driven often reignites debate about their exogenous or endogenous treatment in macroeconomic models. Our framework is able to account for various transmission channels, including not only trade relationships but also …nancial linkages through interest rates, equity prices, and exchange rates (see Dees et al. (2007) for more details).
Building on Kilian and Park’s (2009) structural VAR analysis of the effects of oildemand and supplyshocks on the U.S. stock market, this paper studies the responses of a broader set of stock markets in six OECD member countries. The focus is on the differences and commonalities in the response of stock prices in net oil exporting and net oil importing economies during 1974-2011. Structural oil price shocks aid our understanding of historical fluctuations in stock returns – in particular of the 2008 stock market crash. I find that unexpected shortfalls in globaloilsupply have no significant impact on the stock market in any of the six countries. While an increase in global aggregate demand consistently raises oil prices and cumulative stock returns, the effect is more persistent for net oil exporters and more pronounced for Norway. Other, e. g., precautionary oildemandshocks have a detrimental impact on the stock market in oil importing countries, a statistically insignificant effect for Canada, and a significantly positive effect for Norway. Oil prices account for a larger fraction of the forecast error variance in global relative to national stock returns.
The other explanation for inflationary effects of positive oil price changes in Iran is through the Dutch disease phenomenon and within the ”spending effects” as sug- gested by Corden (1984). The ”spending effect” happens because higher oil prices lead to higher wages or profits in the oil related sectors, thus increasing aggregate ef- fective purchasing power and demand in the economy. While the price of the tradeable sector (oil and manufacturing) is exogenously determined in international markets, the price of the non-tradeable sector, which includes services, is determined within the domestic market. A component of increased demand is shifted to the non-tradeable sector, causing push-demand inflation in these sectors. In this case, we have assumed the immobility between tradeable and non-tradeable sections. Therefore, we will not face a transfer of workers toward the booming service section from the oil and manu- facturing section. However, if we assume the mobility of labor forces in the economy, the booming non-tradable section absorbs workers from oil industry and manufac- turing sections, leading to an increase in wages in the tradable section as well. Since prices in the tradable section are determined from outside of the domestic market, their profit margin will fall and they will be forced to downsize their operations. This phenomenon is described by Corden (1984) as ”indirect de-industrialization”. Real import response to a shock on positive changes in real oil prices is positive and lasts until the end of period. The increasing response of real import for the first quarters after initial shock is significantly different from zero. The positive response of real imports to positive oil price shocks act as a built-in stabilizer, mitigating the inflationary effects of increased money supply after positive oil price shocks. The long-run decreasing trend, albeit not statistically significant, of CPI inflation may be due to increased import volumes.
of oil price shocks on the UK economy may have developed over time. However, as argued by Kilian (2014), the idea of analysing the responses of nominal interest rate to oildemand and supplyshocks within a time-varying parameter VAR is not practical for two reasons. Firstly, the methodology underlying our structural VAR requires long samples with su¢ cient variation in oildemand and oilsupplyshocks to ensure e¢ cient estimation. Secondly, our identifying assumptions hold only using data at monthly frequency. However, it is well documented that time- varying parameter VARs are computationally infeasible when using monthly data. This shortcoming does not apply to the recent generation of DSGE models which are able to disentangle the responses of monetary policy to oildemand and oilsupplyshocks. Indeed, recent advances in DSGE modelling of endogenous oil price shocks provide a useful solution in this direction. In particular, such DSGE models are able to distinguish between several causes of ‡uctuations in the globaldemand for industrial commodities and to estimate the impact of alternative policy choices. Therefore, one of the objectives of Chapter 2 and 3 is to develop a DSGE model in order to analyse the response of UK monetary policy to di¤erent types of oil price shocks.
In 2003, the USA invaded Iraqi and the price of oil suddenly increased from 27 to 35 USD a barrel. Then the world economy presented a recovery at the end of 2003 and throughout the year 2004. The growth rate of the gross domestic product (GDP) in several regions of the world have increased. This period was also characterized by an oil prices due to increased globaldemand, especially in China and Asia. According to the AfDB (2005) high oil prices are attributable to a rise in globaldemand rather than to supply side factors. The price of oil increased to an almost 60 percent. This increasing trend continued until 2005 where the oil price increased to $50 per barrel approximately $15 per barrel higher than in the first quarter of 2004, and remained above this level for the rest of 2005 and 2006.
Identifying and measuring shocks in the market for energy is of paramount importance for policy-makers (e.g. a central bank trying to control expectations about consumer price infla- tion), producers and consumers in an economy, as well as investors in the stock and commodi- ties markets. Therefore, it is no surprise that there exists a large academic literature employing structural vector autoregressions (SVARs). In this literature the estimated innovations from the VAR can be used to measure oil (and other energy) shocks to variables of interest such as out- put, price inflation, and a short term interest rate; see for example Bernanke, Gertler and Watson (1997). However, as it has been shown recently by authors such as Kilian (2009), Baumeister and Peersman (2013), and Lütkepohl and Net˘sunajev (2013), accurate measure- ment of oilshocks presupposes that we are able to decompose oil price dynamics into changes caused by demand or supply factors. This is because the intensity and transmission of oil de- mand shocks is different from that of oilsupplyshocks. Additionally, the effects of various oilshocks can have a diverse impact in an economy, so that, for example, monetary authorities need to identify the nature of the shock in order to react accordingly. A demand-driven increase in the price of oil will also result in an increase of the produced quantity of oil, which may be attributed to better prospects about global economic growth. In contrast, positive supply side shocks in the price of oil are expected to decrease the quantity of oil as well as output while at the same time causing a stagflation effect by pushing total (headline) consumer inflation to increase.
We focus our analysis on the main variables of interest in our models (agriculture, manufacturing, services). Figure 13 displays the rolling IRF for the agriculture sector to negative and positive oil prices. The results show that the negative changes in oil prices cause the agriculture sector to fluctuate more than effect of the positive oil changes. Also, the response of the agriculture sector to the negative shocks varies from one sample to another. In the samples that end with the first years of the 1980's we notice that after a negative first year after the shock, the sector picks up and gains from the reverse of domestic demand towards domestic supply for agricultural products. This was the same for the samples ending with years from 1986 to 2000, but with a lesser magnitude. While the effect for the years of the last decade were all positive, reflecting the effect of revaluation of LYD and the rapid increase in oil prices. Once we add the last two years of the sample (2011, 2012), on the other hand, the sample reverses its course and decreases severely by the negative oil changes reflecting the effect of the violence that took place in Libya during those years.
For the purpose of designing and implementing appropriate macroeconomic policies, it is essential to identify various shocks and analyse their impacts on the economy. In particular, in the wake of recent global recession, it is time to reassess the conventional beliefs about the nature of macroeconomic shocks that are playing crucial roles in an economy. This paper revisits the issue of identification of macroeconomic shocks in ASEAN countries, using an alternative identification scheme where the aggregate demand (AD) and aggregate supply (AS) shocks are allowed to be correlated. The origin of the recession lies in the adverse aggregate demand shock and the persistence of current recession essentially depends on how the demandshocks affect an economy. If the demand shock has only temporary effects on the employment and output level, then we may expect an economy to recover quickly, even without any demand management policy.
However, Kilian (2009) argues that the impact of oilshocks varies depending on the underlying source of oilshocks. He states that the common beliefs in the literature before 2009 was that changes in oil prices were mainly driven by oilsupply disruptions, and those led to the existence of major recessions in the US. Kilian argues that those beliefs are no longer valid. Therefore, Kilian (2009) distinguishes between oilsupplyshocks, aggregate demandshocks, and oil-specific demandshocks based on the underlying source causing oil prices to surge. In particular, he points out that aggregate demandshocks are driven by booming world economy, whereas oil-specific demandshocks are driven by precautionary demand for oil in the crude oil market due to concerns about future oil shortfalls. Killian (2009) also indicates that oilsupplyshocks are result from oil production shortfall from oil producing countries.
The linkages between oil price and stock returns has come to the forefront of public attention and this potentially because of the increase in uncertainty of the energy sector, that impacts directly and indirectly the financial markets. The problems have caused there to be a concern with a re- examination of what exactly can be the explication of the negative connection between oil price shocks and the stock returns. The negative reaction of real stock prices to the increase in oil prices is attributed according to several authors to the direct effects of this increase in terms of cash flows and inflation. This argument is shared by several authors who document that oil price shocks lead to rising inflation and unemployment and therefore depress macroeconomic growth and financial assets (Shimon and Raphael, 2006). In fact, the oil price can corporate cash flow since oil price constitutes a substantial input in production. In addition, oil price changes can influence significantly the supply and demand for output at industry sector and even at the whole economy level and therefore decrease the firm performance through its effect on the discount rate for cash flow because the direct effect that may exert on the expected rate of inflation and the expected real interest rate. These direct and indirect effects of the high volatility in oil prices seem likely to increase uncertainty at firms and in the economy. In this line, Bernanke (1983) and Pindyck (1991) argue that higher change in energy prices creates uncertainty about future energy price and incites, consequently, firms to postpone irreversible investment decisions in reaction to the profit prospects. The negative reaction of real stock prices to the increase in oil prices is also confirmed in O‟Neil et al. (2008) for US, UK and France, Park and Ratti (2008) for US and 12 European oil importing countries, and Nandha and Faff (2008) for global industry indices (except for attractive industries). Ciner (2001) introduced nonlinear effects and confirms the same results according to which there is a significant negative connection between oil price shocks and real stock returns.
This paper investigates the economic consequences of country-speci…c oilsupplyshocks for the globaleconomy in terms of their impacts on real output, oil prices, interest rates and real equity prices. It complements the extensive literature that exists on the e¤ects of globaloilsupplyshocks investigated in a series of papers by Kilian ( 2008b , 2009 ), Hamilton (2009) , and Cashin et al. (2014) , among others. This is an important literature which has been particularly helpful in identi…cation of the demand and supply factors that lie behind oil price changes, but cannot be used to identify the e¤ects of country-speci…c oilsupplyshocks which is relevant when the focus of the analysis is to provide answers to counterfactual questions regarding the possible macroeconomic e¤ects of oil sanctions, or region-speci…c supply disruptions due to wars or natural disasters. To this end, we …rst develop a model of the globaloil market and derive an oil price equation which takes account of developments in the world economy as well as the prevailing oilsupply conditions. We then integrate this within a compact quarterly model of the globaleconomy comprising 27 countries, with the euro area being treated as a single economy, using a dynamic multi-country framework …rst advanced by Pesaran et al. (2004) , known as the Global VAR (or GVAR for short). This approach allows us to analyze the international macroeconomic transmission of the e¤ects of country-speci…c oilsupplyshocks, taking into account not only the direct exposure of countries to the shocks but also the indirect e¤ects through secondary or tertiary channels. The individual country-speci…c models are solved in a global setting where core macro- economic variables of each economy (real GDP, in‡ation, real exchange rate, short and long-term interest rates, and oil production) are related to corresponding foreign variables, (also known as "star " variables) constructed to match the international trade pattern of the country under consideration. Star variables serve as proxies for common unobserved factors and a¤ect the globaleconomy in addition to the set of common observable variables (oil prices and global equity prices). We estimate the 27 country-speci…c vector autoregressive models with foreign variables (VARX* models) over the period 1979Q2 to 2013Q1 separately and then combine these with the estimates from the globaloil market, which we refer to as the GVAR-Oil model. The combined model is used for a number of counterfactual exercises. In particular, we examine the direct and indirect e¤ects of shocks to Iranian and Saudi Ara- bian oil output on the world economy, on a country-by-country basis, and provide the time pro…le of the e¤ects of country-speci…c oilshocks on oil prices, real outputs across countries, and real equity prices.
In this paper, we developed a quarterly model for oil markets, taking into account both globalsupply and demand conditions, which was then integrated within a compact multi- country model of the globaleconomy utilizing the GVAR framework, creating a regionally disaggregated model of oilsupply and demand. Oil supplies were determined in country- speci…c models conditional on oil prices, with oil prices determined globally in terms of aggregate oil supplies and world income. The combined model, referred to as the GVAR-Oil model, was estimated using quarterly observations over the period 1979Q2-2013Q1 for 27 countries (with the euro area treated as a single economy), and tested for the key assumptions of weak exogeneity of global and country-speci…c foreign variables, and parameter stability. The statistical evidence provided in the appendix supports these assumptions and shows that only 11 out of the 158 tests of weak exogeneity that were carried out were statistically signi…cant at the 5% level. Also, most regression coe¢ cients turned out to be stable, although we found important evidence of instability in error variances which is in line with the well documented evidence on "great moderation" in the United States. To deal with changing error variances we used bootstrapping techniques to compute con…dence bounds for the impulse responses that we report.
consumer prices get more pronounced from the mid-1990s onwards and climb considerably in the 2000s. This evidence underscores the importance of allowing for time variation in studying the e¤ects of physical oil production shortfalls.
Normalization on oil price. Given that the focus of much previous research has been on the e¤ects of an unanticipated increase in the price of oil, we now consider alternatively the e¤ect of an oilsupply shock normalized such that it raises the real price of oil by 10 percent on impact at each point in time. The latter thought experiment is used by Blanchard and Galí (2010) as a benchmark for their intertemporal comparison. The normalized time-varying impulse responses are shown in panel B of Figure 1. For this scenario, we …nd a more muted reaction of economic activity in the latter part of the sample. This …nding complies well with existing empirical evidence on the time-varying e¤ects of oil price shocks (e.g. Edelstein and Kilian 2007; Herrera and Pesavento 2009; Blanchard and Galí 2010; Ramey and Vine 2012). This experiment shows that a 10 percent rise in the real price of oil is currently accompanied by an oil production shortfall of 0.5 to 1.5 percent. To elicit the same oil price move in the 1970s, a decline in the physical supply of crude oil of up to 12 percent is required. Thus, despite the assertion by Blanchard and Galí (2010) that "what matters [...] to any given country is not the level of globaloil production, but the price at which …rms and households can purchase oil" (p. 17), it appears that a larger reduction in oil production causes more severe macroeconomic consequences even if the oil price increases by the same amount. 4
External Variable: Three variables came to our mind when choosing the appropriate variables to represent external shock. Studies have established that external shock were transmitted through exchange rate, oil price and net capital inflow either through trade or equity investment. There is serious debate about the superiority of one over the other in the literature. For instance, Yu (2003) used trade. Akinlo (2004) emphasized the role of FDI in promoting economic growth. The trade openness is computed as the sum of non-oil export and import as ratio of GDP. The choice of non-oil export is because export supply component of Nigeria’s economy is dominated by the oil export, which has little to do with the trade regime, adopted over the years. Therefore, the share of import shows the penetration of the Nigeria’s economy while the non-export indicates the degree of Nigeria’s penetration of the world market. Okoh (2004) defined openness in the same way and pointed out that this index of openness is synonymous with the idea of neutrality in the trade policy.
Second, global aggregate demandshocks exert a substantial long-term positive effect on merchandise exports and the trade balance, whereas such effects have only a minor and temporary effect on merchandise imports. These responses seem weaker than the responses to oilsupplyshocks, even though they are more persistent. They also only appear after about 6 months. The substantial positive effects of aggregate demandshocks on merchandise exports modify the important position of Australia’s merchandise exports in global economic activity. This finding indicates that further investment in exporting industries may provide substantial benefits, with the modest short-term rise in merchandise imports implying growth in Australian economic activity alongside other countries. In addition, while aggregate demandshocks explain half of the variation in merchandise imports in the short term, they do not contribute to the variation in merchandise exports. However, the contribution of aggregate demandshocks to variations in merchandise exports increases over time.
Uppal (1993), Coeurdacier (2005), Kollmann (2006a,b) and Obstfeld (2006) study portfolio choice in models with consumption home bias; in those settings, there are just output shocks, and the only traded assets are domestic and foreign stocks. Those models can only generate equity home bias when the substitution elasticity between domestic and imported goods is (roughly speaking) smaller than unity. Intuitively, a country that receives a negative output shock experiences an improvement of its terms of trade; when the substitution elasticity between local and imported goods is low, then the terms of trade improvement is so strong that the return on local equity rises compared to the return on foreign equity; thus, local equity has a high (relative) return in states of the world in which the country’s output is low; this makes holding local equity attractive, and induces investors to mainly invest their wealth in local stocks. By contrast, when the substitution elasticity exceeds unity, then the relative return on local equity drops, when local output falls, and hence foreign equity is a better hedge for output ‡uctuations. Hence, a model with just supplyshocks only generates equity home bias under the condition that a negative
remained at their August 1980 levels for the next three months (or for that matter the next eight years).
Second, it seems intuitive that a shock to OPEC oil production that persists for years will be much more serious than a short-lived disruption of production. Quantitative dummy measures do not allow such distinctions. A temporary production shortfall lasting one month is treated the same as a persistent loss of OPEC productive capacity, as long as the magnitude of the initial fall is the same. Nor does the quantitative dummy measure make a distinction between a gradual decline in production and a sudden drop or between an immediate and a delayed drop in production. It also fails to account for the positive effect of a partial or complete reversal of the exogenous supply shortfall over time. Such exogenous dynamics of oilsupply (that are distinct from the endogenous supply responses triggered by an exogenous oil shock) must not be ignored in assessing the dynamic effect of exogenous events on the price of oil. The analysis in section 3 documented the quantitative importance of such dynamics. In short, the use of quantitative dummy measures will distort the statistical relationship between estimated production shortfalls and oil prices, which plays a central role in our understanding of the effects of oilsupplyshocks.
In order to identify shocks which have asymmetric e¤ects across countries, we follow a common approach in the empirical literature: in the tradition of empirical open-economy macroeconomics, we measure all variables except trade and domestic relative prices in terms of cross-country di¤erentials (see Clarida and Galí  and Glick and Rogo¤ ). As is well understood, the alternative of expanding the empirical system to include both US and ROW variables has the clear disadvantage of running quickly against the constraint imposed by data availability, exhausting any degree of freedom in the empirical analysis. A potential issue in working with cross-country di¤erentials is raised by the (implicit) assumption of symmetry across economic areas — an assumption that is clearly unappealing in studies focused on small open economies. In our case, however, a symmetry assumption is not obviously consequential, as we compare a large country such as the US, with a large aggregate of OECD countries — we will return to this issue in Section 5.
This paper studies the impact of oil prices on the Czech economy from several perspectives. First, we analyze the available data on the sources and use of energy in the Czech Republic and the determinants of energy prices for the domestic consumer. Second, our main tool is a com- putable general equilibrium (CGE) model of the Czech economy, which models the production structure in great detail. From both perspectives we find a rather moderate effect of oil prices on the economy. We demonstrate that this result is rather robust with respect to reasonable changes in the assumptions. It is worth emphasizing that we do not analyze the factors behind world oil price developments. The Czech Republic is a small open economy with no real impact on the world oil price. Although there has been much public debate on oil price issues, to our knowl- edge there has been no detailed analysis of the reaction of the Czech economy to the oil price. Furthermore, even outside the Czech Republic, there are very few models analyzing the price shock in such industrial detail.