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 United States, 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 consumer's expenditure patterns evolve in response to energy price shocks? How do energy price shocks affect U.S. real output, inflation, and stock prices? 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 the price of oil 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.
It has been 40 years since the oil crisis of 1973/74. This crisis has been one of the defining economic events of the 1970s and has shaped how many economists think about oil price shocks. In recent ...years, a large literature on the economic determinants of oil price fluctuations has emerged. Drawing on this literature, we first provide an overview of the causes of all major oil price fluctuations between 1973 and 2014. We then discuss why oil price fluctuations remain difficult to predict, despite economists' improved understanding of oil markets. Unexpected oil price fluctuations are commonly referred to as oil price shocks. We document that, in practice, consumers, policymakers, financial market participants, and economists may have different oil price expectations, and that, what may be surprising to some, need not be equally surprising to others.
•There are many alternative indicators of global real economic activity.•New evidence and new insights help understand the differences.•Indices derived from shipping rates and commodity price factors ...are most suitable.•Pros: accurate timing, long monthly series, global coverage, robust to structural change.•Systematic evidence of a global slowdown after 2011 in commodity markets.
It is widely understood that the real price of globally traded commodities is determined by the forces of demand and supply. One of the main determinants of the real price of commodities is shifts in the demand for commodities associated with unexpected fluctuations in global real economic activity. There have been numerous proposals for quantifying global real economic activity. We discuss which criteria a measure of global real activity must satisfy to be useful for modeling industrial commodity prices, we examine which of the many alternative measures in the literature are most suitable for applied work, and we explain why some popular measures are inappropriate for modeling industrial commodity prices. Given these insights, we examine the question of whether there has been a slowdown in global real economic activity between 2011 and 2016 and by how much. Drawing on a range of new evidence, we show that the global commodity price boom of the 2000s appears to have been largely transitory and that the partial recovery after 2016 has been fueled by the strength of advanced economies rather than China. Our analysis has important implications for the design of structural models of commodity markets, for the analysis of the transmission of commodity price shocks to commodity-importing and -exporting economies, and for commodity price forecasting.
A comparison of the effects of exogenous shocks to global crude oil production on seven major industrialized economies suggests a fair degree of similarity in the real growth responses. An exogenous ...oil supply disruption typically causes a temporary reduction in real GDP growth that is concentrated in the second year after the shock. Inflation responses are more varied. The median CPI inflation response peaks after three to four quarters. Exogenous oil supply disruptions need not generate sustained inflation or stagflation. Typical responses include a fall in the real wage, higher short-term interest rates, and a depreciating currency with respect to the dollar. Despite many qualitative similarities, there is strong statistical evidence that the responses to exogenous oil supply disruptions differ across G7 countries. For suitable subsets of countries, homogeneity cannot be ruled out. A counterfactual historical exercise suggests that the evolution of CPI inflation in the G7 countries would have been similar overall to the actual path even in the absence of exogenous shocks to oil production, consistent with a monetary explanation of the inflation of the 1970s. There is no evidence that the 1973-1974 and 2002-2003 oil supply shocks had a substantial impact on real growth in any G7 country, whereas the 1978-1979, 1980, and 1990-1991 shocks contributed to lower growth in at least some G7 countries.
The U.S. Energy Information Administration (EIA) regularly publishes monthly and quarterly forecasts of the price of crude oil for horizons up to 2 years, which are widely used by practitioners. ...Traditionally, such out-of-sample forecasts have been largely judgmental, making them difficult to replicate and justify. An alternative is the use of real-time econometric oil price forecasting models. We investigate the merits of constructing combinations of six such models. Forecast combinations have received little attention in the oil price forecasting literature to date. We demonstrate that over the last 20 years suitably constructed real-time forecast combinations would have been systematically more accurate than the no-change forecast at horizons up to 6 quarters or 18 months. The MSPE reductions may be as high as 12% and directional accuracy as high as 72%. The gains in accuracy are robust over time. In contrast, the EIA oil price forecasts not only tend to be less accurate than no-change forecasts, but are much less accurate than our preferred forecast combination. Moreover, including EIA forecasts in the forecast combination systematically lowers the accuracy of the combination forecast. We conclude that suitably constructed forecast combinations should replace traditional judgmental forecasts of the price of oil.
The distinction between the price of gasoline in the U.S. and the price of crude oil in global markets is often ignored in discussions of the impact of higher energy prices. This article makes ...explicit the relationship between demand and supply shocks in these two markets. Building on a recently proposed structural VAR model of the global crude oil market, it explores the implications of a joint VAR model of the global market for crude oil and the U.S. market for motor gasoline. It is shown that it is essential to understand the origins of a given gasoline price shock, when assessing the responses of the price of gasoline and of gasoline consumption, since each demand and supply shock is associated with responses of different magnitude, pattern and persistence. The article assesses the overall importance of these shocks in explaining the variation in U.S. gasoline prices and consumption growth, as well as their relative contribution to the evolution of U.S. gasoline prices since 2002.
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.
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.
Despite their widespread use as predictors of the spot price of oil, oil futures prices tend to be less accurate in the mean-squared prediction error sense than no-change forecasts. This result is ...driven by the variability of the futures price about the spot price, as captured by the oil futures spread. This variability can be explained by the marginal convenience yield of oil inventories. Using a two-country, multi-period general equilibrium model of the spot and futures markets for crude oil we show that increased uncertainty about future oil supply shortfalls under plausible assumptions causes the spread to decline. Increased uncertainty also causes precautionary demand for oil to increase, resulting in an immediate increase in the real spot price. Thus the negative of the oil futures spread may be viewed as an indicator of fluctuations in the price of crude oil driven by precautionary demand. An empirical analysis of this indicator provides evidence of how shifts in the uncertainty about future oil supply shortfalls affect the real spot price of crude oil.
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