Fossil fuel prices and economic policy uncertainty– A regime-switching approach

Abstract

The study investigates the impact of fossil fuel prices on the regime-switching dynamics of economic policy uncertainty for the global economy. The period of investigation spans 25 years; comprising monthly data for the period of 1998:01 to 2023:03 and, due to its propensity to accommodate shocks, swings and shifts in the data, the technique of analysis employed is the Markov Switching Dynamic Regression. The principal component analysis (PCA) method was used in obtaining a composite index for the fossil fuel prices. The results obtained show evidence of regime-switching behaviour with five (5) times persistence of low to high global economic policy uncertainty. In addition, the study finds significant counter-cyclical and pro-cyclical effects of fossil fuel prices on global economic policy uncertainty; especially under the regime of high uncertainty. These results are consistent with the results for the composite index of fossil fuel prices but with alternate persistence effects. These suggest that policymakers should be concerned in stabilizing fluctuating fossil fuel prices in order to contain its spiralling and uncertain effects on the global economic policy. More so, governments should devise series of low carbon-emission means for home and industrial uses to ultimately reduce the excessive demand for fossil fuel so as to crash its prices in the international market.