How do oil price shocks affect consumer prices?

Oil Price Pass-Through into Core Inflation

“…We took a conservative approach under the rationale that the existence of one factor is almost sure, while the presence of additional factors is not so sure (results with r = 3 are available in Appendix B). The choice of six lags, despite being larger than what selected by standard information criteria, is in line with the existing literature (see for example Edelstein and Kilian, 2009;Gao et al, 2014).…”

“…Figure 5 shows the estimated pass-through into core PCE prices via the common component when the model is estimated on a longer sample starting in 1974 (left plot), and when the model is estimated on a shorter sample starting in 1996 (right plot). The choice of 1996 is for comparison with the euro area analysis performed in Section 4, while 1974 is the starting date of a large number of empirical analysis (for example Aastveit, 2014;Gao et al, 2014). The results in Figure 5 confirm that the oil price pass-through into core inflation has decreased over time.…”

“…The model is estimated on a sample starting in 1984:M1 and ending in 2016:M6, which contrasts with a large part of the literature on oil price shocks that uses samples starting in 1973/1974 (for example Kilian, 2009;Aastveit, 2014;Gao et al, 2014). There are at least two good reasons to consider a sample starting in 1984 rather than 1974.…”

“…In the literature, oil price shocks are often identified by assuming that energy prices are predetermined with respect to the US/EA economy at monthly frequency (for a thorough discussion of this identification strategy see Kilian and Vega, 2011), which in practice means using a Choleski decomposition with the oil price ordered first (for example Gao et al, 2014;Stock and Watson, 2016). The restriction in (4) is in the same spirit, though stronger, as we are imposing that the oil price is exogenous, rather than predetermined, to US/EA prices.…”

“…Moreover, other papers have used dynamic factor models to analyze disaggregate prices (Cristadoro et al, 2005;Altissimo et al, 2009;Boivin et al, 2009;Reis and Watson, 2010, among others), but none have used these models to study the oil price pass-through. Finally, Gao et al (2014) study the effect of oil price shocks on a number of disaggregate US consumer prices using VAR techniques; they find a significant effect only on the price of energy-intensive goods but do not distinguish between macroeconomic and idiosyncratic effects.…”