An International Perspective on Oil Price Shocks and U.S. Economic Activity - Dallas Fed

The effect of oil price shocks on U.S. economic activity seems to have changed since the mid-1990s. A variety of explanations have been offered for the seeming change — including better luck, the reduced energy intensity of the U.S. economy, a more flexible economy, more experience with oil price shocks and better monetary policy. These explanations point to a weakening of the relationship between oil prices shocks and economic activity rather than the fundamentally different response that may be evident since the mid-1990s. Using a dynamic stochastic general equilibrium model of world economic activity, we employ Bayesian methods to assess how economic activity responds to oil price shocks arising from supply shocks and demand shocks originating in the United States or elsewhere in the world. We find that both oil supply and oil demand shocks have contributed significantly to oil price fluctuations and that U.S. output fluctuations are derived largely from domestic shocks. JEL codes: F41, Q43 * Nathan S. Balke, Department of Economics, Southern Methodist University, Dallas, TX 75275. [email protected]. Stephen P. A. Brown, Research Department, Federal Reserve Bank of Dallas 2200 North Pearl Street, Dallas, TX 75201. [email protected]. Mine K. Yücel, Research Department, Federal Reserve Bank of Dallas, 2200 North Pearl Street, Dallas TX 75201. [email protected]. The authors thank Mario Crucini, Fred Joutz, Luca Guerrieri, William Helkie,Lutz Kilian, Prakash Loungani, Erwan Quintin, Tara Sinclair, Mark Wynne and Carlos Zarazaga for helpful comments and discussions and Stefan Avdjiev and Zheng Zeng for capable research assistance. The authors retain all responsibility for omissions and errors. The views in this paper are those of the authors and do not necessarily reflect the views of the Federal Reserve Bank of Dallas or the Federal Reserve System.