31 August 2011

Oil Shocks and Good Times for the Global Economy

This post revisits the topic of oil prices and economic growth which was explored here earlier this year.  A new paper by Tobias Rasmussen and Agustin Roitmanfrom the IMF (here in PDF) titled "Oil Shocks in a Global Perspective: Are they Really that Bad?" which explores the largely uncharted territory of the effects of oil price increases on economic growth at the global level.  The figuer at the top shows the countries with GDPs that increase following and oil shock (those bars above the horizontal axis) and those the see a decrease (those at the left side, the US and Japan are highlighted in yellow).

Here are the paper's conclusions:
Conventional wisdom has it that oil shocks are bad for oil-importing countries. This is grounded in the experience of slumps in many advanced economies during the 1970s. It is also consistent with the large body of research on the impact of higher oil prices on the U.S. economy, although the magnitude and channels of the effect are still being debated. In this paper, we offer a global perspective on the macroeconomic impact of oil prices. In doing so, we are filling a void of research on the effects of oil prices on developing economies.

Our findings indicate that oil prices tend to be surprisingly closely associated with good times for the global economy. Indeed, we find that the United States has been somewhat of an outlier in the way that it has been negatively affected by oil price increases. Across the world, oil price shock episodes have generally not been associated with a contemporaneous decline in output but, rather, with increases in both imports and exports. There is evidence of lagged negative effects on output, particularly for OECD economies, but the magnitude has typically been small.

Controlling for global economic conditions, and thus abstracting from our finding that oil price
increases generally appear to be demand-driven, makes the impact of higher oil prices stand out more clearly. For a given level of world GDP, we do find that oil prices have a negative effect on oil-importing countries and also that cross-country differences in the magnitude of the impact depend to a large extent on the relative magnitude of oil imports. The effect is still not particularly large, however, with our estimates suggesting that a 25 percent increase in oil prices will cause a loss of real GDP in oil-importing countries of less than half of one percent, spread over 2–3 years. One likely explanation for this relatively modest impact is that part of the greater revenue accruing to oil exporters will be recycled in the form of imports or other international flows, thus contributing to keep up demand in oil-importing economies. We provide a model illustrating this effect and find supporting empirical evidence.

The finding that the negative impact of higher oil prices has generally been quite small does not mean that the effect can be ignored. Some countries have clearly been negatively affected by high oil prices. Moreover, our results do not rule out more adverse effects from a future shock that is driven largely by lower oil supply than the more demand-driven increases in oil prices that have been the norm in the last two decades. In terms of policy lessons, our findings suggest that efforts to reduce dependence on oil could help reduce the exposure to oil price shocks and hence costs associated with macroeconomic volatility.13 At the same time, given a certain level of oil imports, developing economic linkages to oil exporters could also work as a natural shock absorber.
If oil shocks are not so bad in aggregate, and associated with "good times for the global economy" then maybe the price of oil should be higher?

H/T VoxEu


  1. A couple of observations from the report.
    1. Looking at the correlations, (a) are uniformly stronger in 1990 to 2010 than in 1970 to 1990. (b) For oil-importers, the strongest correlations are with richer countries. Not surprising, as energy consumption is highly correlated with GDP.
    2. Of the OECD oil-importers, the leading positive country is the UK. It is also the most borderline being a major oil producer in 1980s & 90s, along with being the home to a disproportionately large oil company sector.
    3. Although globally over 40 years there is a net positive impact of higher prices, this is due to demand factors. Artificially inflating prices at the present is likely to be less positive. For instance in the past Greece, Portugal, Spain and Italy have had strong positive impacts of oil shocks. I hardly envisage that increased prices will do them any favours at present.

  2. I would add that a lot of little countries with positive effect is not the same as a positive effect globally. In addition, oil is not even close to a market product. Prices rises are tolerated if opec and the such believe they won't kill long term demand. They tend to be followed by big dips to bankrupt high cost producers with major capital investors. Likewise low prices can be aimed for by producers precisely because there is fear about client economies.

  3. It is surely unsurprising that demand is strong when economies are strong and that this pushes the price higher. The same would be true of metals, for example.

    I'm unsure why a sharp oil price rise is associated with the word 'shock' - this seems very rooted in the seventies.

    What is the antonym of an 'oil shock'? For example when oil hit $10 in 1985. An 'oil windfall'?

  4. Exactly. And real GDP grew by more than 3% from 1985 to 1999, while the price of crude oil remained below $20 -- except for a brief 'spike' for Desert Storm I -- until the end of the millenium. Demand was high; oil was cheap. Keeping oil cheap was part of the US's strategy to bankrupt the Soviet Union.

  5. I agree with Joseph Cox that smaller countries are poor indicators since they "oil is not even close to a market product." More broadly, the countries that are affected the most should be the ones with the highest per capita consumption. So it's no surprise that the U.S. has suffered more than most. Also, I think the report soft peddles the downturn that follows in OECD countries. One would expect the response in GDP to lag. It takes time for the spike to cause businesses to slow production and lay off people. Any negative GDP is not good. A drop of 0.8% is significant. There is fear right now because the latest figure for the U.S. is +0.1%.

  6. A closer look at the graph shows that the countries on the far right - doing great when oil prices are high - are Angola and Ethiopia. Yeah, that's what I want the United States to look like.

    Apparently Roger makes so much money in his tenured faculty position that any increase in energy prices would be trivial to him. When the rest of us are living a Botswana-style standard of living, he'd still be living the good life.

    When they start laying off faculty to cover the increased price of energy, maybe Roger's attitude will change.

  7. -6-Mark B.

    Dude, it is not the fat faculty salary, but rather the money from Exxon and the cigarette companies that has me living large ;-)

    More seriously, had you read The Climate Fix you'd know that I am a strong advocate of cheaper energy. Thanks!

  8. -6- Roger,

    Yeah, sure, and I'll bet you get a sweet parking benefit, too!

  9. The graph in the blog is misleading - as the paper itself clearly shows that high oil prices affect every type of nation negatively with the exception of oil exporters.

    Not a very strong paper also.

    There is no examination to isolate the effect of the US dollar. As oil is denominated in dollars, the impact of rising or falling dollar value relative to other currencies is itself a huge potential factor in measurement of oil price impact.

  10. Roger - FYI OT I know you're a football fan.

    ‘FA launches ‘Let’s Kick Climate Change Denial Out of Football’ campaign.’

    “Football fans who make offensive chants about wind turbines could face stiff jail sentences under plans by the government and the Football Association to ‘get tough’ with climate change deniers.”


  11. Let's make energy cheaper by taxing it. Great logic for people who have money to burn. You've said explicitly that you want to start with a low energy tax and then ratchet it up. That's your route to cheap energy?

    We have 'cheaper' energy right now. We get it from coal and oil and natural gas.