The Role of Oil Price Shocks in Causing U.S. Recessions

Abstract

Although oil price shocks have long been viewed as one of the leading candidates for explaining U.S. recessions, surprisingly little is known about the extent to which oil price shocks explain recessions. We provide the first formal analysis of this question with special attention to the possible role of net oil price increases in amplifying the transmission of oil price shocks. We quantify the conditional recessionary effect of oil price shocks in the net oil price increase model for all episodes of net oil price increases since the mid-1970s. Compared to the linear model, the cumulative effect of oil price shocks over course of the next two years is much larger in the net oil price increase model. For example, oil price shocks explain a 3% cumulative reduction in U.S. real GDP in the late 1970s and early 1980s and a 5% cumulative reduction during the financial crisis. An obvious concern is that some of these estimates are an artifact of net oil price increases being correlated with other variables that explain recessions. We show that the explanatory power of oil price shocks largely persists even after augmenting the nonlinear model with a measure of credit supply conditions, of the monetary policy stance and of consumer confidence. There is evidence, however, that the conditional fit of the net oil price increase model is worse on average than the fit of the corresponding linear model, suggesting much smaller cumulative effects of oil price shocks for these episodes of at most 1%.

Lower Oil Prices and the U.S. Economy: Is This Time Different?

“…There is a large empirical literature on potential asymmetries in the economy's response to positive and negative oil price shocks (see, e.g., Wada 2011, 2015;Herrera and Karaki 2015;Kilian and Vigfusson 2015). Although the evidence thus far has not been supportive of models implying strongly asymmetric responses at the aggregate level, there are comparatively few episodes of large oil price declines, so this latest episode provides an opportunity to have a fresh 21 look at the evidence.…”

Markov Switching Oil Price Uncertainty

“…In particular, we find that the effect of an oil price shock on the growth rate, captured by the impulse response function, and the effect of oil price uncertainty on the growth rate, captured by ϕ , are significantly larger in regime 2, suggesting that the U.S. economy tends to be particularly vulnerable to oil price shocks prior to and during recessions. In this regard, Kilian and Vigfusson , p. 1749), in their investigation of the conditional effects of oil price shocks during episodes of net oil price increases, argue that ‘the magnitude of the conditional response is correlated with a number of indicators of macroeconomic conditions such as consumer confidence, financial stress, the share of oil in GDP, and interest rate expectations that may indicate a heightened vulnerability of the economy to oil price shocks, but most of the time variation appears linked to the prior evolution of the real price of oil’. Thus, our empirical results are not only consistent with the literature, but also contribute to the literature, as we find that oil price uncertainty has a larger negative effect on the growth rate at times when the economy is vulnerable to oil price shocks.…”

New insights into the US stock market reactions to energy price shocks

“…In addition, Qatar, UAE, and UK stock markets are found to be the most responsive to oil price shocks. Kilian and Vigfusson (2014) measure the recessionary effect of oil price shocks in the US. Findings show that oil price shocks explain a 3% decrease in real US economic growth in the late 1970s and early 1980s and a 5% decrease during the financial crisis.…”