Abstract
This paper contributes to better understand the dynamic interactions between effective exchange rate (EER) and oil price for an oil-importing country like the U.S. by considering a Time-Varying Parameter VAR model with the use of monthly data from 1974:01 to 2019:07. Our findings show a depreciation after an oil price shock in the short-run for any period of time, although the pattern of long-run responses of U.S. EER is diverse across time periods, with an appreciation being observed before the mid-2000s and after the mid-2010s, and a depreciation between both periods. This diversity of response should lead policy makers to react differently in order to counteract such shocks. Furthermore, the reaction of oil price to an appreciation of U.S. EER is negative and different over time, which may generate different adverse effects on investment. The knowledge of such effects may help financial investors to diversify their investments in order to optimize the risk-return profile of their portfolios.
Highlights
The relationship between nominal oil price and U.S effective exchange rate (EER) seems not to be the same over time
This paper considers a recursively identified bivariate time-varying parameter (TVP)-VAR model to analyze the relationship between U.S EER and oil price from the mid-1970s onwards
We consider monthly data for the nominal oil price, which is defined as the spot price of West Texas Intermediate in USD per barrel and is taken from Federal Reserve Economic Data (FRED), and the U.S nominal narrow effective exchange rate published by the Bank for International Settlements
Summary
The relationship between nominal oil price and U.S effective exchange rate (EER) seems not to be the same over time. Regarding the studies analyzing the time-varying relationship between oil price and U.S exchange rate, [3], on the one hand, consider weekly data from 7 January 2000 to 25 July 2014 to study the linear and non-linear causality between the two variables and the effects of structural breaks in the volatility of crude oil and exchange rate markets, but they dedicate one section of their paper to analyze the time-varying influence of the two variables They display the one-period-ahead impulse responses of oil price to an exchange rate shock and those of exchange rate to an oil price shock (without credible intervals) over time in their Fig 2, showing that an appreciation of USD reduces oil price while an increase in oil price has led to a USD depreciation except for the periods 2002-2004 and 2009-2013, where an appreciation is observed.
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