Oil price shocks and macroeconomic responses: does the exchange rate regime matter?

Abstract

AbstractThe sharp fluctuations in oil prices in recent years provide an opportunity to empirically test Friedman's hypothesis that flexible exchange regimes better absorb real external shocks. This paper empirically examines whether the responses of real output, consumer prices, interest rates and real exchange rates differ across exchange rate regimes. Since the effects of oil price shocks depend on whether the economy is a net importer or a net exporter of oil, the sample used in this study is composed of nine Organisation for Economic Cooperation and Development major oil‐importing countries. The results show that only consumer prices and real exchange rates exhibit relatively faster and smoother adjustment to their long‐run equilibrium when the adopted de facto exchange rate regime is flexible, supporting Friedman's hypothesis. Also, panel Granger causality tests suggest a feedback from real effective exchange rates and inflation rates to the real oil price, supporting the argument that oil price shocks are not purely exogenous to developed economies.