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Not All Oil Price Shocks are Alike: Disentangling Demand and Supply Shocks in the Crude Oil Market
TL;DR: In this paper, a structural decomposition of the real price of crude oil in four components is proposed: oil supply shocks driven by political events in OPEC countries; other oil supply shock; aggregate shocks to the demand for industrial commodities; and demand shocks that are specific to the crude oil market.
Abstract: Using a newly developed measure of global real economic activity, a structural decomposition of the real price of crude oil in four components is proposed: oil supply shocks driven by political events in OPEC countries; other oil supply shocks; aggregate shocks to the demand for industrial commodities; and demand shocks that are specific to the crude oil market. The latter shock is designed to capture shifts in the price of oil driven by higher precautionary demand associated with concerns about the availability of future oil supplies. The paper quantifies the magnitude and timing of these shocks, their dynamic effects on the real price of oil and their relative importance in determining the real price of oil during 1975-2005. The analysis also sheds light on the origins of the major oil price shocks since 1979. Distinguishing between the sources of higher oil prices is shown to be crucial for assessing the effect of higher oil prices on U.S. real GDP and CPI inflation. It is shown that policies aimed at dealing with higher oil prices must take careful account of the origins of higher oil prices. The paper also quantifies the extent to which the macroeconomic performance of the U.S. since the mid-1970s has been determined by the external economic shocks driving the real price of oil as opposed to domestic economic factors and policies.
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TL;DR: In this paper, the reaction of U.S. real stock returns to an oil price shock differs greatly depending on whether the change in the price of oil is driven by demand or supply shocks in the oil market.
Abstract: It is shown that the reaction of U.S. real stock returns to an oil price shock differs greatly depending on whether the change in the price of oil is driven by demand or supply shocks in the oil market. The demand and supply shocks driving the global crude oil market jointly account for 22% of the long-run variation in U.S. real stock returns. The responses of industry-specific U.S. stock returns to demand and supply shocks in the crude oil market are consistent with accounts of the transmission of oil price shocks that emphasize the reduction in domestic final demand.
1,427 citations
Cites background or methods or result from "Not All Oil Price Shocks are Alike:..."
...…of production.14 It is also consistent with related evidence based on the responses of consumption and investment expenditures in Edelstein and Kilian (2007, 2009) and with evidence in Barsky and Kilian (2004) against the interpretation of oil price shocks as aggregate supply or aggregate…...
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...Kling (1985), for example, concluded that crude oil price increases are associated with stock market declines. Chen, Roll and Ross (1986), in contrast, suggested that oil price changes have no effect on asset pricing....
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...Following Kilian (2009), these identifying restrictions may be motivated as follows: (1) crude oil supply will not respond to oil demand shocks within the month, given the costs of adjusting oil production and the uncertainty about the state of the crude oil market; (2) increases in the real price…...
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...…inelastic supply of suitable ships, will be indicative of higher demand for shipping services arising from increases in global real activity (see Kilian, 2009 for further discussion).4 One of the chief advantages of this monthly index based on bulk dry cargo ocean freight rates is that it…...
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...Using oil futures market data since 1989, Alquist and Kilian (2009) show that this correlation may be as high as 80% notwithstanding the use of a completely different data set and methodology....
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TL;DR: This article explored similarities and differences between the run-up of oil prices in 2007-08 and earlier oil price shocks, looking at what caused these price increases and what effects they had on the economy.
Abstract: This paper explores similarities and differences between the run-up of oil prices in 2007–08 and earlier oil price shocks, looking at what caused these price increases and what effects they had on the economy. Whereas previous oil price shocks were primarily caused by physical disruptions of supply, the price run-up of 2007–08 was caused by strong demand confronting stagnating world production. Although the causes were different, the consequences for the economy appear to have been similar to those observed in earlier episodes, with significant effects on consumption spending and purchases of domestic automobiles in particular. Absent those declines, it is unlikely that the period 2007Q4–2008Q3 would have been characterized as one of recession for the United States. This episode should thus be added to the list of U.S. recessions to which oil prices appear to have made a material contribution.
1,314 citations
TL;DR: The authors developed a structural model of the global market for crude oil that for the first time explicitly allows for shocks to the speculative demand for oil as well as shocks to flow demand and flow supply.
Abstract: SUMMARY
We develop a structural model of the global market for crude oil that for the first time explicitly allows for shocks to the speculative demand for oil as well as shocks to flow demand and flow supply. The speculative component of the real price of oil is identified with the help of data on oil inventories. Our estimates rule out explanations of the 2003–2008 oil price surge based on unexpectedly diminishing oil supplies and based on speculative trading. Instead, this surge was caused by unexpected increases in world oil consumption driven by the global business cycle. There is evidence, however, that speculative demand shifts played an important role during earlier oil price shock episodes including 1979, 1986 and 1990. Our analysis implies that additional regulation of oil markets would not have prevented the 2003–2008 oil price surge. We also show that, even after accounting for the role of inventories in smoothing oil consumption, our estimate of the short-run price elasticity of oil demand is much higher than traditional estimates from dynamic models that do not account for for the endogeneity of the price of oil. Copyright © 2013 John Wiley & Sons, Ltd.
1,156 citations
Cites background from "Not All Oil Price Shocks are Alike:..."
...Research disseminated by CEPR may include views on policy, but the Centre itself takes no institutional policy positions....
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TL;DR: The authors found that futures prices of different commodities in the US became increasingly correlated with each other and this trend was significantly more pronounced for commodities in two popular GSCI and DJ-UBS commodity indices.
Abstract: This paper finds that, concurrent with the rapid growing index investment in commodities markets since early 2000s, futures prices of different commodities in the US became increasingly correlated with each other and this trend was significantly more pronounced for commodities in the two popular GSCI and DJ-UBS commodity indices. This finding reflects a financialization process of commodities markets and helps explain the synchronized price boom and bust of a broad set of seemingly unrelated commodities in the US in 2006-2008. In contrast, such commodity price comovements were absent in China, which refutes growing commodity demands from emerging economies as the driver.
990 citations
Posted Content•
TL;DR: In this paper, a number of the key issues in this debate are addressed: What are energy price shocks and where do they come from? How responsive is energy demand to changes in energy prices? How do consumers' expenditure patterns evolve in response to energy price spikes? How does energy price changes affect real output, inflation, stock markets and the balance-of-payments? Why do energy price increases seem to cause recessions, but energy price decreases do not seem to lead to expansions?
Abstract: Large fluctuations in energy prices have been a distinguishing characteristic of the U.S. economy since the 1970s. Turmoil in the Middle East, rising energy prices in the U.S. and evidence of global warming recently have reignited interest in the link between energy prices and economic performance. This paper addresses a number of the key issues in this debate: What are energy price shocks and where do they come from? How responsive is energy demand to changes in energy prices? How do consumers' expenditure patterns evolve in response to energy price shocks? How do energy price shocks affect real output, inflation, stock markets and the balance-of-payments? Why do energy price increases seem to cause recessions, but energy price decreases do not seem to cause expansions? Why has there been a surge in gasoline prices in recent years? Why has this new energy price shock not caused a recession so far? Have the effects of energy price shocks waned since the 1980s and, if so, why? As the paper demonstrates, it is critical to account for the endogeneity of energy prices and to differentiate between the effects of demand and supply shocks in energy markets, when answering these questions.
930 citations
Cites background or methods or result from "Not All Oil Price Shocks are Alike:..."
...Building on a structural VAR model of the global crude oil market proposed in Kilian (2007c), I explore the implications of a joint VAR model of the global market for crude oil and the U.S. market for motor gasoline....
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...Thus, little is lost by studying the effect of unweighted energy price shocks, as has been demonstrated in Edelstein and Kilian (2007b)....
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...All energy prices have been weighted by the nominal expenditure share on energy to obtain a measure of the gains and losses of households’ purchasing power associated with energy price fluctuations (see Edelstein and Kilian 2007a)....
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...The gasoline market is modeled as follows: 20 In the context of a theoretical model of the spot and futures market for crude oil, Alquist and Kilian (2007) show that measures of the percent spread of the oil futures price over the current spot price of oil may also be used to measure the…...
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...For further discussion of the data the reader is referred to Kilian (2007c)....
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References
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TL;DR: This paper used a flexible approach to characterize the nonlinear relation between oil price changes and GDP growth and reported clear evidence of nonlinearity, consistent with earlier claims in the literature that oil price increases are much more important than oil price decreases, and increases have significantly less predictive content if they simply correct earlier decreases.
Abstract: This paper uses a flexible approach to characterize the nonlinear relation between oil price changes and GDP growth The paper reports clear evidence of nonlinearity, consistent with earlier claims in the literature-- oil price increases are much more important than oil price decreases, and increases have significantly less predictive content if they simply correct earlier decreases An alternative interpretation is suggested based on estimation of a linear functional form using exogenous disruptions in petroleum supplies as instruments The evidence suggests that oil shocks matter because they disrupt spending by consumers and firms on certain key sectors
1,721 citations
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TL;DR: In this article, the authors used a flexible approach to characterize the nonlinear relation between oil price changes and GDP growth and reported clear evidence of nonlinearity, consistent with earlier claims in the literature that oil price increases are much more important than oil price decreases.
1,620 citations
01 Jan 1997
TL;DR: The authors developed a VAR-based technique for decomposing the total economic effects of a given exogenous shock into the portion attributable directly to the shock and the part arising from the policy response.
Abstract: Macroeconomic shocks such as wil price increases induce a systematic (endogenous) response of monetary policy. We develop a VAR-based technique for decomposing the total economic effects of a given exogenous shock into the portion attributable directly to the shock and the part arising from the policy response to the shock.(This abstract was borrowed from another version of this item.)
1,556 citations
TL;DR: In this paper, the reaction of U.S. real stock returns to an oil price shock differs greatly depending on whether the change in the price of oil is driven by demand or supply shocks in the oil market.
Abstract: It is shown that the reaction of U.S. real stock returns to an oil price shock differs greatly depending on whether the change in the price of oil is driven by demand or supply shocks in the oil market. The demand and supply shocks driving the global crude oil market jointly account for 22% of the long-run variation in U.S. real stock returns. The responses of industry-specific U.S. stock returns to demand and supply shocks in the crude oil market are consistent with accounts of the transmission of oil price shocks that emphasize the reduction in domestic final demand.
1,427 citations
"Not All Oil Price Shocks are Alike:..." refers background in this paper
...despite the surge in oil prices in recent years (also see Kilian and Park 2007 )....
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1,185 citations