Vance Ginn Sam Houston State University Fall 2012 vance.ginn@shsu.edu
� A higher oil price has preceded 10 out of the last 11 recessions, making it a (arguably) leading indicator of business cycles. � The Energy Information Administration (2012) projects that by 2035 the nominal oil price will remain volatile and could reach $235 per barrel. ◦ This compares with a range of $85 to $110 per barrel in 2011. � Recent evidence finds that the underlying source of oil price disruptions matters (Kilian 2009) � Since the 1980s, the primary sources of oil price shocks have been from factors related to the following: ◦ Oil demand—increased oil consumption in China and India ◦ Expectations of future oil supply disruptions (i.e. precautionary demand)—instability in the Middle East ◦ I define these collectively as "global demand for oil shocks"
� Other economic models that assume (explicitly or implicitly) that an oil price disturbance is from a shifting supply curve, which I define as an “oil price shock,” are not well specified after 1980. � After estimating a four-variable VAR with quarterly data from 1974:1-2011:3 and constructing a structural VAR with long-run restrictions, I compare the effects from identified shocks on macroeconomic variables. � I find that the effects are greater from a global demand for oil shock than those from an oil price shock. � Therefore, policymakers should not necessarily be concerned with an oil price shock driven by an oil supply disruption, but how their policies influence, or react, to global demand for oil shocks. 3
� Three primary transmission mechanisms for oil price disruptions through the macroeconomy: ◦ Aggregate supply: � Kim & Loungani (1992)—effect on producers � Rotemberg & Woodford (1996)—imperfect competition � Finn (2000)—perfect competition ◦ Aggregate demand: � Edelstein & Kilian (2009)—reduction in purchasing power � Mehra & Peterson (2005)—decline in durable goods consumed � Ramey & Vine (2011)—fewer automobiles purchased ◦ Term structure of interest rates: � Bernanke, Gertler, & Watson (1997)—systematic monetary policy � These mechanisms may be less relevant because of the declining effects from oil price shocks since the 1980s (Barsky & Kilian, 2004; Blanchard & Galí, 2007) 4
� Depending on whether oil disruptions are supply or demand driven, the macroeconomic effects of an “oil- related shock” could be quite different (Kilian, 2009) � Supply driven “oil price shocks”: ◦ Shapiro & Watson (1988) ◦ Bernanke, Gertler, and Watson (1997)—factors other than oil price shocks caused the 1970's recessions ◦ Hamilton and Herrera (2004)—exogenous oil price shocks were to blame for these recessions � Demand driven “global demand for oil shocks”: ◦ Kilian ( AER, 2009)—causes after 1980 ◦ Baumeister and Peersman (2009)—global economic disruptions, an increasing number of substitutes for oil, and more energy- efficient technologies ◦ Hamilton (2009) & Kilian ( Comment, 2009)—global economic slowdown in 2008 5
� Since the seminal paper by Sims (1980), structural VAR models have been the workhorse for separating the effects of shocks with few identifying restrictions. � I impose long-run restrictions similar to the approaches by: ◦ King & Morley (2007)—study of the long-run dynamics of the Phillips Curve relationship ◦ Valcarcel (2011)—analyze the link between the stock market and macroeconomic aggregates � By imposing these long-run restrictions, I attempt to disaggregate structural shocks. 6
� I define a stationary vector of quarterly variables as: x t = [ Δ u t , rea t or Δ o t , Δ y t , Δπ t ]' ◦ Δ u t is the first difference of the average monthly unemployment rate ◦ rea t denotes the average of the detrended monthly index of global "real economic activity" constructed by Kilian (2009b) ◦ Δ o t represents the first difference of the average monthly real oil price ◦ Δ y t is the first difference of the log of real GDP ◦ Δπ t refers to the first difference of the average monthly annualized rate of headline CPI inflation ◦ Δπ ' t represents the core CPI inflation. 7
� I consider a reduced-form stationary VAR model: � I estimate the reduced form VAR model, impose fully recursive long-run identifying restrictions to A(1), and assume the structural disturbances ( ε t ) are orthogonal. � I present the structural VAR representation as: 8
� Quarterly data are for the sample from 1974:1 to 2011:3, the period when all variables were available. ◦ Monthly average of the level of the unemployment rate (u) ◦ Log of real gross domestic product (y) ◦ Headline ( π ) and core ( π ') annualized inflation rates for the CPI ◦ Real oil price is the refiner’s acquisition cost of imported crude oil deflated by the headline CPI (o) ◦ Index of global real economic activity (rea) from Kilian (n.d.) � Proxy of global aggregate demand for commodities from various bulk dry cargo freight rates. � Kilian deflates this index by the headline CPI, linearly detrends it, and deviates it from the long-run trend 9
Unemployment Rate Real Economic Activity 12% 12% 80 80 10% 10% 40 40 8% 8% 0 0 6% 6% -40 -40 4% 4% 2% 2% -80 -80 1975 1980 1985 1990 1995 2000 2005 2010 1975 1980 1985 1990 1995 2000 2005 2010 Real Oil Price Real Gross Domestic Product $60 $60 $14 $14 $50 $50 $12 $12 $40 $40 $10 $10 $30 $30 $8 $8 $20 $20 $6 $6 $10 $10 $0 $0 $4 $4 1975 1980 1985 1990 1995 2000 2005 2010 1975 1980 1985 1990 1995 2000 2005 2010 Annualized Headline CPI Inflation Annualized Core CPI Inflaiton 16% 16% 16% 16% 12% 12% 12% 12% 8% 8% 8% 8% 4% 4% 4% 4% 0% 0% 10 -4% -4% 0% 0% 1975 1980 1985 1990 1995 2000 2005 2010 1975 1980 1985 1990 1995 2000 2005 2010
� Considering that a VAR model is sensitive to the order of integration for each of the variables and a unit root is one type of non-stationary series, I check each of the variables for a unit root. In regression: π π ' u rea o y Tests: -1.84 -3.76 -1.14 -1.52 -2.44 -2.24 Constant + trend: ADF (0.68) (0.02)** (0.92) (0.82) (0.35) (0.47) -2.06 -4.23 -1.37 -1.09 -2.75 -3.36 PP (0.56) (0.00)** (0.87) (0.93) (0.22) (0.06)* -2.37 -3.63 -1.25 -1.99 -2.34 -1.95 Constant: ADF (0.15) (0.01)** (0.65) (0.29) (0.16) (0.31) -2.07 -4.10 -1.52 -1.20 -2.39 -1.67 PP (0.26) (0.00)** (0.52) (0.68) (0.15) (0.44) In regression: Δ u Δ rea Δ o Δ y Δπ Δπ ' Tests: Constant: -5.05 -7.21 -6.96 -4.87 -4.65 -5.01 ADF (0.00)** (0.00)** (0.00)** (0.00)** (0.00)** (0.00)** -5.52 -11.10 -9.42 -7.96 -8.59 -7.57 PP (0.00)** (0.00)** (0.00)** (0.00)** (0.00)** (0.00)**
(b) Accumulated Response of Real Oil Price (a) Accumulated Response of Unemployment Rate Response of Real Economic Activity .1 20 .0 16 -.1 12 -.2 8 -.3 4 -.4 0 5 10 15 20 25 30 35 40 5 10 15 20 25 30 35 40 (c) Accumulated Response of Output (d) Accumulated Response of Inflation .6 .8 .4 .6 .2 .4 .0 .2 -.2 -.4 .0 5 10 15 20 25 30 35 40 5 10 15 20 25 30 35 40 Oil Price Shock with Headline Inflation Oil Price Shock with Core Inflation 12 Global Demand for Oil Shock with Headline Inflation Global Demand for Oil Shock with Core Inflation
(a) Unemployment Rate (b) Real Economic Activity (a) Unemployment Rate (b) Real Oil Price AS AD AS AD AS AD AS AD Period s.e. NRU GDO Period s.e. NRU GDO Period s.e. NRU OP Period s.e. NRU OP 1 0.2 39.8 40.7 19.2 0.4 1 10.6 38.8 53.5 4.6 3.1 1 0.2 66.0 5.7 27.8 0.6 1 13.3 2.0 95.1 0.1 2.9 4 0.3 42.0 41.3 12.0 4.7 4 19.4 36.0 61.1 1.4 1.5 4 0.3 76.4 4.7 15.6 3.3 4 14.8 3.2 92.5 0.6 3.7 8 0.3 40.8 41.6 11.6 5.9 8 22.3 38.6 58.8 1.1 1.5 8 0.3 72.0 7.4 16.9 3.7 8 14.9 3.6 91.5 0.6 4.3 16 0.3 42.1 41.2 11.0 5.7 16 22.9 40.4 57.1 1.1 1.4 16 0.3 71.9 7.5 17.0 3.7 16 15.0 3.6 91.4 0.7 4.3 40 0.3 42.2 41.1 10.9 5.7 40 23.0 40.6 56.9 1.1 1.4 40 0.3 71.9 7.5 17.0 3.7 40 15.0 3.6 91.4 0.7 4.3 (c) Output (d) Core Inflation (c) Output (d) Core Inflation AS AD AS AD AS AD AS AD Period s.e. NRU GDO Period s.e. NRU GDO Period s.e. NRU OP Period s.e. NRU OP 1 0.7 44.8 35.1 19.4 0.7 1 0.4 6.5 2.2 0.3 90.9 1 0.7 78.2 8.8 12.1 0.9 1 0.4 3.2 8.1 0.0 88.6 4 0.8 44.2 31.3 15.3 9.2 4 0.5 6.4 17.0 2.2 74.5 4 0.8 75.4 7.6 9.2 7.8 4 0.5 10.0 12.7 4.3 73.1 8 0.8 42.4 33.4 14.1 10.1 8 0.5 8.2 17.2 3.2 71.4 8 0.9 72.0 9.6 10.2 8.2 8 0.5 14.5 12.5 5.5 67.6 16 0.8 43.2 33.2 13.6 10.0 16 0.5 8.4 18.6 3.4 69.6 16 0.9 71.7 9.6 10.2 8.5 16 0.5 14.2 12.5 6.0 67.3 40 0.8 43.3 33.2 13.5 10.0 40 0.5 8.5 18.6 3.4 69.6 40 0.9 71.7 9.6 10.2 8.5 40 0.5 14.2 12.5 6.0 67.3 Real Economic Activity & Real Oil Price & Core Inflation Core Inflation 13
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