Oil Market Shocks and the Economy in a Quarterly Structural Vector Error Correction Model of the United States Economy

Abstract

This paper evaluates the impacts of oil market shocks on the economy using a structural vector error correction model of the United States (US) economy. The model is estimated with quarterly data for ten endogenous oil market and macroeconomic variables. Supply and demand driven oil market shocks are identified by examining the pattern of their impacts on oil market variables and the real US gross domestic product (GDP). The implied supply/demand elasticities, and elasticities of the real US GDP to these shocks are presented. The estimated quarterly oil price elasticity of the real US GDP under the oil price shock has a range of -0.04 to -0.004 with a mean of -0.02 about three years after the initial shock. The impacts of supply shocks on the real US GDP are also found to be significant. The quarterly price elasticity of global oil demand to an oil price shock has a range of -0.06 to -0.02 with a mean of -0.04, and the global oil supply elasticity under the global oil demand shock has a range of 0.10 to 0.2 with a mean of 0.11. These findings show that supply, demand and non-systematic oil market shocks have significant price and economic implications, even after controlling for monetary variables. In addition, the findings emphasize that the impacts of oil market shocks are complex and that elasticities estimated from multi-equation systems are conditional on the responses of other model components. Future work will use the model to explore the economic implications of historical oil market events.