The effect of oil supply shocks on US economic activity: What have we learned?

Abstract

Summary Estimated responses of real oil prices and US gross domestic product (GDP) to oil supply disruptions vary widely. We show that most variation is attributable to differences in identification assumptions and in the model specification. Models that allow for a large short‐run price elasticity of oil supply imply a larger response of oil prices and a larger, longer lived contraction in US real GDP. We find that, if we condition on a range of supply elasticity values supported by microeconomic estimates, the differences in the oil price responses diminishes. We also examine the role of lag length, of using pre‐1973 data, alternative measures of real economic activity and using the median response function instead of the modal structural model.

Oil Prices, Exchange Rates and Interest Rates

“…Following Frankel (2008), we use the nominal U.S. one year treasury rate, adjusted for inflation over the preceding years as a proxy for expected inflation. 7 Throughout the paper, trade-5 For a review of merits of this approach and a comparison with alternative approaches to modeling the global oil market see Herrera and Rangaraju (2019) and Kilian (2019a). 6 The Kilian index of global real economic activity is based on data for bulk dry cargo ocean shipping freight rates.…”

“…the variables in the oil market block 9 Further discussion of the sensitivity of oil market VAR estimates to this bound can be found in Kilian and Murphy (2012), Zhou (2019), and Herrera and Rangaraju (2019).…”

“…Recent examples include Fratzscher, Schneider and Van Robays (2014), Bützer, Habib and Stracca (2016), and Beckmann, Czudaj and Vipin (2018). 2 Examples include Fattouh, Kilian and Mahadeva (2013), Kilian and Lee (2014), Kilian (2017), Herrera and Rangaraju (2019), Zhou (2019), and Cross, Nguyen and Tran (2019). 3 Implicitly or explicitly the argument articulated in these studies is based on the premise that major changes in the real price of oil reflect exogenous supply disruptions in OPEC countries such that the correlation between changes in the real price of oil and changes in the U.S. real exchange rate can be given a causal interpretation.…”

Refining the workhorse oil market model

“…Kilian and Murphy () introduced a structural vector autoregressive (VAR) model of the global oil market that for the first time explicitly incorporated storage demand and allowed for forward‐looking behavior in oil markets. This model has become the workhorse model for the analysis of oil markets (e.g., Cross, ; Fattouh et al, ; Herrera & Rangaraju, ; Kilian, ; Kilian & Lee, ). It has been used, for example, to study the role of financial speculation in oil markets, the impact of the US shale oil boom, and the causes of the 2014 oil price decline.…”

Facts and Fiction in Oil Market Modeling

“…It is also worth emphasizing that there is no evidence that explicitly modeling uncertainty about identifying restrictions as proposed by BH makes any difference in practice, compared to mainstream approaches to Bayesian inference for structural VAR models (see Herrera and Rangaraju 2019). 1 This evidence (and related evidence in the literature) confirms that the substantive results of Kilian and Murphy (2014) are robust to changes in the estimation period, data choice, loss function, model specification, and econometric approach, provided the prior on the oil supply elasticity is economically plausible.…”