Oil and the Great Moderation

Abstract

We assess the extent to which the period of great U.S. macroeconomic stability since the mid-1980s can be accounted for by changes in oil shocks and the oil share in GDP. To do this we estimate a DSGE model with an oil-producing sector before and after 1984 and perform counterfactual simulations. We nest two popular explanations for the Great Moderation: (1) smaller (non-oil) real shocks; and (2) better monetary policy. We fi nd that the reduced oil share accounted for as much as one-third of the infl ation moderation and 13% of the growth moderation, while smaller oil shocks accounted for 11% of the infl ation moderation and 7% of the growth moderation. This notwithstanding, better monetary policy explains the bulk of the infl ation moderation, while most of the growth moderation is explained by smaller TFP shocks.

Saudi Arabia and the Oil Market

“…Backus and Crucini () partially endogenise oil output by modelling it as the sum of two terms: an exogenous shock meant to represent unpredictable OPEC supply changes; and a term related to economic activity, which represents competitive oil supply. In contrast, in our model, as in Nakov and Pescatori (2010 a , b ), the oil market is characterised by the presence of a dominant oil supplier with competitive fringe.…”

“…Our model differs from Nakov and Pescatori (2010 a , b ) in three main dimensions: First, we consider a more detailed structure of oil producers, taking into account the process of capital accumulation in the oil industry . Second, we take into account the distinct trends in oil production, oil price and the general economy.…”

Oil prices and the macroeconomy

“…Through the lens of a DSGE model, they find that disappearance of this negative connection after 1982 can explain a significant fraction of the moderation in U.S. output. Nakov and Pescatori (2010) find that oil related factors play an important role in reducing output volatility, although they are not the most important factor. On the other hand, Bjornland et al (Forthcoming), using a Markov Switching Rational Expectations New-Keynesian model, find that oil price volatility does not play a major role in explaining the Great Moderation.…”

“…Numerous papers have considered extensions to the two works just cited. In Nakov and Pescatori (2010), optimal monetary policy is considered in a model with a dominant oil producer. Kormilitsina (2011) looks at optimal policy in a medium-scale estimated DSGE model of the U.S. economy.…”

The Oil Price-Macroeconomy Relationship Since the Mid-1980s: A Global Perspective

“…Only supply determined oil price shock would in fact trigger a downturn in real economic activity, not necessarily being stag ‡ationary; di¤erently, demand determined oil price shocks, being driven by the same momentum driving real activity, would not be recessionary. The resilience shown by industrialized countries to the 2008 oil price shock, rather than being explained by a declining oil share (Nakov and Pescatori, 2010), lower real wage rigidity (Blanchard and Galí, 2010;Blanchard and Riggi, 2009) and lower volatility of oil demand and supply shocks (Baumeister and Peersman, 2009), may then be seen as the consequence of the better anchoring of in ‡ation expectations, in the face of demand driven oil price shocks (Kilian, 2010).…”