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FEAS 2011674
IR 448
ABSTRACT
This paper provides informative and critical perspective about the selected
Selected five articles discusses the effects of oil prices shocks from different
perspectives. Not only reasons of oil price fluctuation but also consequences of
shocks taken into account from recent history to 21st century for US and World
economies. At the end of the paper, we will have documented how oil prices
policy-makers economically.
1. INTRODUCTION
concerned with the sources of fluctuations in the price of oil, with the
transmission of oil price shocks, with the role of speculation in oil markets, with
measuring oil price expectations in financial markets, and with oil price
forecasting. His research interests also include time series econometrics,
empirical macroeconomics.
Oil price have been the one of the most important determinants of the oil
market and energy diplomacy since oil became heavily used in industry in early
20th century. Powerful actors in energy markets has tried to influence and
used as a primary input in almost all industrial sectors. On the other hand, major
oil producer such as Russia, Iraq or UAE also heavily depend on oil prices
oil prices are considered one of most unstable commodity prices for a long year.
Figure 1 shows that West Texas Intermediate(WTI) average annual barrel prices
spot market (WTI) have fluctuated for forty years despite of the fact that most of
the actors desire the stability of oil prices. Many economist focused on this
this issue. Before analyzing the studies of Killian, I want to emphasize some
1976-2017
Clearly, whether an oil price shock occurred, and how large this shock was,
depends on which measure of the oil price expectations we use. There are three
Specification which takes into account all price changes in oil prices as an oil
household do not respond small changes in oil prices, but respond large one
Specification which is defined as the difference between the current price of oil
and the maximum price over the previous year (or alternatively the previous
three years) if the current price exceeds the previous maximum, and zero
otherwise
Structural VAR (Vector Autoregressive). VAR models are among the most
macroeconomics shocks and about how various shocks have contributed to the
VAR models have been used successfully for economic and business forecasting
for modeling risk and volatility, and for the construction of forecast scenarios.
Lutz Kilian is one of the user of structural VAR model to measure impact of oil
real price of oil, global crude oil production, global real economic activity and
change in global crude oil stocks with 12 lagged variables which means any
change in variables before 12 months can affect todays real oil price. Moreover,
supply shocks and demand shocks in energy markets. The latter distinction can
It is widely accepted that energy prices in general, and crude oil prices in
conditions dating back to the early 1970s. Endogeneity here refers to the fact
that not only do energy prices affect the U.S. economy, but that there is reverse
the price of energy. Clearly, both the supply of energy and the demand for
economic activity and interest rates. Economist and statistician need to use
leading example of this approach is the net oil price increase measure proposed
by Hamilton (1996, 2003). Hamilton (2003) suggests that, although the price of
crude oil itself is not exogenous with respect to U.S. macroeconomic aggregates,
which nominal oil prices exceed their maximum value over the previous three
years) is. The purpose of the statistical transformation of oil prices is to isolate
the component of the price of crude oil that can be attributed to political events
relationship, lending credence to the practice of treating net oil price increases as
exogenous. According to Kilian, the fact that net oil price increases are not
measures of exogenous oil price shocks can also be seen more directly. Kilian
(2008b) shows that oil price shocks detected by the nonlinear transformation
proposed by Hamilton (2003) occur at times when exogenous oil supply shocks
in the Middle East were conspicuously absent and that there are major
exogenous events that are not followed by oil price shocks. Hence, oil price
series must be treated as endogenous whether they have been transformed to net
variables against the energy price shocks. Energy prices are separated from other
commodity prices in terms of four extent. Firstly, energy prices change sharply
and profoundly which is different than other commodities. Secondly, demand for
energy is inelastic. For example, households cannot shut down their heating
thermostat easily even gasoline prices rise high. Third factor is that energy
that, major oil price increases have accompanied with recessions and inflations
in history.
electricity, gasoline, crude oil, oil in time series used by Kilians papers. Then he
which channels transmit energy price changes to firms and household decision.
There are four direct effect of energy price changes on households decision
directly. One of the transmission mechanism is that higher energy prices reduces
discretionary income, which is remaining income left after energy bills are paid
future (precautionary effect). Last one is that consumers might decrease their
purchases. These four direct effect is covered largely on literature, on the other
hand there are also indirect effect such as the fact that consumers purchases
sector. Moreover, there are also transmission mechanism that links energy price
decision, Lutz Kilian analyzes the effect on energy prices on consumption and
responses. The strikingly large response of 1.47 for heating oil and coal is
likely due to households ability to store heating oil in tanks. This storage feature
allows households to delay purchases of new heating oil when the price of
heating oil is high and to fill the tank completely when prices are low. In
contrast, electricity and natural gas are inherently unstorable, and gasoline may
not be stored for safety reasons beyond the tank capacity of a car. Indeed, the
declines in electricity consumption and in natural gas use are smaller and not
decline of -0.76 percent the consumption of motor vehicle and parts. The most
When we look deep in subsectors of automobile industry, we can show the how
vehicles. Although, elasticity of new foreign auto, which is known better energy
efficient than American cars, is very low and statistically insignificant, SUV
sales drop -1.5 percent as a result of one percent increase in energy prices.
energy price rises one percent, investment on mining industry rises +1.39
investment (purchases for new houses). Then Kilian conclude that energy prices
distinguish supply shock effect, demand shock effect and oil specific demand
shock. In much of the earlier literature, supply shocks are much emphasized on
energy prices changes as in 1974 Oil crises. However, Kilian argue that demand
shocks and oil specific demand shocks have much more importance on the
energy prices. Figure 2 shows us oil supply shock has statistically insignificant
effect on real price of oil. On the other hand, demand side shock has persistent
and profound effect on energy prices. Oil specific shocks mainly caused by
precautionary purchases by households and firms when prices are low.
Figure 2
Kilian conclude that demand side shocks dominated the energy prices as
contrary to general belief since 1973. Then we can suggest that oil price increase
between 2003-2008 is originated by unanticipated increase demand for input
addition, impact of supply shock on 1973 oil embargo might be very less than
demand before the embargo might lead to 4 times increase in energy prices in
U.S.
2.2 2nd Article Oil and the Macroeconomy since the 1970s
Lutz Kilian stressed in this paper that how relationship between main
economic variables such as GDP, inflation and productivity and oil prices have
been evolved since 1970. It is commonly believed that there is a close link from
political events in Middle East to changes in the price of oil, and in turn from oil
belief, Kilian stressed that exogenous political events in the Middle East are but
one of several factors driving oil prices, and that the effect of seemingly similar
political events may differ greatly from one episode to the next, in accordance
macroeconomic conditions second belief, he showed that the timing of oil price
increases and recessions is consistent with the notion that oil price shocks may
either because the magnitude of the predicted effect can be shown to be small a
priori or because the theory has implications that are not supported by U.S.
macroeconomic data. It is also showed that oil price shocks are not sufficient to
cause recession in U.S alone, although we know that oil prices cause decline in
real output. On the other hand, oil took small place on the U.S productivity to
change it. Although a number of additional and more elaborate arguments have
been advanced that in principle might establish a link from oil prices to
productivity changes, none of these models can claim solid empirical support.
as an economic term was emerged in 70s and refer to both decline in Gross
Domestic Product and raise in price level(inflation). After oil crises in 1973,
there was the strong belief the relationship between oil prices and general price
level in U.S. However, this relationship is not apparent when we look at the real
data. For example, outbreak of war between Iran and Iraq seem to have had little
invasion of Iraq 2003. Thus, we conclude that disturbances in the oil market are
likely to matter less for U.S. macroeconomic performance than has commonly
been thought.
The other issue that explained by Kilian is where the origin of oil price
events play a role on price of oil. The role of OPEC is considered important on
price of oil because OPEC meeting in 1999 was considered main reason of the
peak in the oil prices in 2001 in March. Such a cartels formation is conducive
when real interest rates low as in 1970s, but it is detrimental when interest rates
high for oil producer. Thus, strong economic expansion could strengthen oil
carters and major recessions weaker them. Under the light of this information,
we can see that pending recession in U.S because of effects of Asian crises in
can conclude that this analysis does not deny the importance of political efforts
aimed at strengthening or sustaining the oil cartel; rather, the point is that such
activities -unlike wars- are not exogenous and that the sustainability of cartels
Second, the role of political events and wars in Middle East. It is widely
believed that sudden and large changes in the price of oil tend to be caused by
unpredictable exogenous political events in the Middle East that represent shifts
of the supply curve for oil. Often these "shocks" are associated with military
events such as the outbreak of wars. Figure 3 show the imported oil price
changes in US between 1971-2003. Clearly, not all so-called oil shocks follow
the same pattern. For example, the period after the October war of 1973, the
period after the collapse of OPEC in late 1985 and the period immediately after
the invasion of Kuwait in 1990 are characterized by sharp spikes in oil prices.
The period following the Iranian revolution of 1978-1979 and that following the
1999 OPEC meeting are, in contrast, characterized by relatively small, but
We conclude that there may have been many plausibly exogenous political
events in the Middle East, but the magnitude and pattern of the subsequent
changes in the price of crude oil varies greatly. Thus, it is far from obvious what
the precise channel is by which exogenous events affect the price of oil and
whether there is a link at all. The explanation is also valid for the role of oil
embargos in World. As we can see, neither cartels nor political events, wars and
embargoes can be seen as a major source of oil price shock in near history.
also affect the price of oil directly by shifting demand for oil.
The importance of shocks to the demand for oil was strikingly illustrated
by the drop in the price of oil following the Asian crisis of 1997-1998. Unlike in
the late 1990s, the upward pressure on oil prices in the 1970s, in this view, was
drove output levels above potential for sustained periods and were followed by
periods of unusually low real interest rates. As these booms gave way to
recessions and increases in real interest rates, oil prices started falling in the
early 1980s and ultimately collapsed in early 1986, despite the best efforts of the
the macroeconomic variables. Also, we can see these demand effect between
2003-mid 2008 oil prices were raised together with the unexpected demand in
It has been 40 years since the oil crises in 1973/74. Most of thing about
the oil market have been changed. For example, new regime in the global crude
order in gas station is known pictures from the 70s all over World. Thats why
America lifted the restriction and regulation in oil market such as price celling
and quantity ceiling that distort market equilibrium. However, even these
regulations cannot prevent the economies from unanticipated oil price shocks.
Lutz Killian states the concise history of the oil price shocks before he
analyzes the reason why oil price expectation and real prices do not match. For
example, the well-known reason of 73-74 crises is the decline in supply because
of the embargo, but there was no fighting in any Arab oil producing countries
and no oil facilities have been destroyed. Instead this war took place in Egypt,
Israel, Syria which are not a major oil producer. There is production cut imposed
agreement between this countries and western oil importer countries that fixed
the oil price for a long time. Also, Kuwait and Saudi oil production was higher
than the normal capacity. In other words, production cut has only reversal effect
on the level production. 75% percent of the increase in the oil prices was caused
After mentioning the demand sided reason of the important oil price shocks, his
component of oil price fluctuations is. It is illustrated that the timing and
magnitude of oil price shocks depends on the measure of oil price expectations.
The reason why economists care about oil price shocks that these shocks
discretionary income that is associated with unexpectedly higher oil prices hence
higher gasoline prices. Consumers who are forced to commute to and from
work, for example, often have little choice, but to pay higher gasoline prices,
which reduces the amount of discretionary income available for other purchases.
Another channel is that oil price shocks affect expectations about the future path
of the price of oil. Such expectations enter into net present value calculations of
future investment projects, the cash flow of which depends on the price of oil.
production facilities for a sport utility vehicle is directly affected by the price of
oil, as is a household's decision which car to buy. What matters for net present
value calculations is not the magnitude of the oil price surprise in the current
period, but the revision the expected path of the future price of oil which enters
the cash flow. In addition, oil price shocks also affect the cash flow of earlier
remain profitable as long as the price exceeds the marginal cost, which depends
on the current price of oil. It is even possible for higher oil prices to cause
guzzling car in response to higher gasoline prices). For this reason, oil prices
2.4 4th Article Oil Price Shocks, Monetary Policy and Stagflation
rigidities nor improved monetary policy responses to oil price shocks are a
the composition of the oil demand and oil supply shocks underlying the real
price of oil. In particular, the surge in the real price of oil between 2003 and mid
pressures more than offset increases in the production of crude oil over the same
time period. The resulting oil price increases reflected a persistent shift in the
economies to cushion the impact of this shock. There is no evidence that oil
Since positive global aggregate demand shocks entail a stimulus for oil-
importing economies, and since they raise oil prices and other industrial
commodity prices only with a delay, their short-run effect on real GDP tends to
be more benign than that of other oil demand or supply shocks. Only as that
initial stimulus fades will the recessionary effects dominate. Thus, rising oil
prices and a robust economy may coexist for several years, as long as the
end of the demand boom, however, will be associated with a recession. The data
indicate that global demand peaked in May 2008 and collapsed in the second
half of 2008. Econometric models suggest that the drop in the real price of oil in
the second half of 2008 reflected both sharply reduced global aggregate demand
The 20032008 oil price shock episode has been different from the 1970s
in that there is no sign that stagflation has made a comeback, although the surge
in the real price of oil was larger than even in the 1970s. Kilian has shown that
policy regime that emphasizes the price stability objective. Indeed, many central
effects of oil demand and supply shocks on the external balances of oil exporters
and oil importers. Our analysis explicitly recognized that oil price changes
reflect at least in part the state of the global economy. He also distinguished
between oil price changes caused by crude oil supply shocks, oil price changes
driven by shocks to global aggregate demand for industrial commodities, and oil
price changes associated with oil-market specific demand shocks such as shocks
effects of oil demand and oil supply shocks on external balances. This
external accounts respond to oil demand and oil supply shocks. For example,
economic theory is informative about the direction and overall pattern of the
response of the oil trade balance to an oil supply shock, but it is quiet about the
financial market integration, the non-oil trade balance may not respond at all to
an oil supply shock or the response could be potentially quite large. In addition,
to date there has been no theoretical analysis of global aggregate demand shocks
predictions. These facts make the empirical analysis of the response of external
Key findings extracted from study are: (1) Global business cycle demand
shocks and oil-specific demand and supply shocks are important for the
determination of external balances. For example, they jointly account for 86% of
the variation in the current account of an aggregate of oil exporters and for 82%
GDP). Oil-market specific demand and supply shocks jointly account for about
associated with the global business cycle account for an additional one-third. For
an aggregate of major oil importers the corresponding shares are lower, but still
large.
(2) The nature of the transmission of oil price shocks depends on the
cause of the oil price increase. For example, positive oil demand shocks are
negative oil supply shocks are associated with a statistically insignificant decline
in years 2 and 3 after the shock, whereas an oil-market specific demand shock
(3) The overall effect of oil demand and supply shocks on the trade
balance of oil importers (and oil exporters) depends critically on the response of
the non-oil trade balance. Empirical evidence on the response of the non-oil
trade balance is especially useful because theory puts few restrictions on that
response. Moreover, the extent to which the non-oil trade balance moves in
nor complete markets model provide a good approximation to the data, and
transmission of oil demand and oil supply shocks under incomplete markets.
(4) In addition to the adjustment of the trade balance and current account,
capital gains or capital losses on foreign assets and liabilities. He found evidence
of systematic valuation effects in response to oil demand and oil supply shocks
for both oil exporters and oil importers. International financial integration
overall has tended to cushion the effect of oil demand and supply shocks on the
change in NFA positions of oil importers and oil exporters. Results highlight the
predicting the effects of oil demand and supply shocks on external balances it is
(5) Finally, our results are of interest for the recent policy debate about
external imbalances. His analysis suggests that shocks to the demand for
Valuation effects, however, have helped cushion the impact of these shocks on
net foreign asset positions. For example, the widening imbalance in the U.S.
current account can be explained to a large extent by the cumulative effect of the
demand shock reflecting the global business cycle as well oil-market specific
demand and supply shocks, yet the impact of these shocks has been cushioned
by valuation effects, suggesting that the recent global oil demand shocks were
not as harmful to the U.S. economy as they would have been in the absence of
REFERENCES
Barsky, R., & Kilian, L. (2004). Oil and the Macroeconomy Since the 1970s.
Baumeister, C., & Kilian, L. (n.d.). Forty Years of Oil Price Fluctuations: Why
the Price of Oil May Still Surprise Us. SSRN Electronic Journal.
Kilian, L. (2009). Oil price shocks, monetary policy and stagflation. London:
CEPR.
Kilian, L., Rebucci, A., & Spatafora, N. (2009). Oil shocks and external
Kilian, L., Murphy, A., & Fomby, T. B. (2013). VAR models in macroeconomics
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113(2): 36398.
Hamilton, James D. 2008. Oil and the Macroeconomy. In The New Palgrave
Macmillan.