Investigating the impact of oil price changes on monetary policy: Oil importing versus oil exporting countries

Abstract

The impacts of oil price changes on global economy are evident through many studies. In this paper, we extend the study by examining the impact of oil price changes on monetary policy behavior and decision empirically. In particular, we seek to reveal if policy function reacts to oil price changes despite its reaction to deviation from policy targeted variables. In addition, we also seek to study how influential oil price changes on economic performance relative to non – oil factors. A mathematical model is used to capture the response of monetary policy rate to oil price changes. The seemingly unrelated regression approach is applied on the panel data for estimating the mathematical monetary policy reaction function. The results are compared between main oil importing versus main oil exporting countries. Our results reveal limited effect of oil price changes on the economy of oil exporting group, hence no response of policy function of this group to oil price changes. However, oil price changes induce higher output gap and inflation in oil importing groups and the policy function of this group is reactive to oil price changes in second sub-period. Monetary policy in oil exporting is more effective on controlling output gap and inflation. The study has revealed that oil dependency factor and effective monetary policy are crucial on determining the effect of oil price changes on economy.