Oil prices, manufacturing goods, and nontradeable services

Abstract

This paper studies the ability of manufacturing-specific shocks to explain oil prices. In an estimated three-region model (US, OPEC, rest of world) incorporating two sectors (manufacturing and services) in the oil-importing economies and featuring cross-border supply chains, such shocks rationalize the observed pattern of a positive comovement between oil prices and the global cyclical gap between manufacturing output and services provision. In the event of manufacturing technology shocks, oil demand, intermediate manufactured goods demand, and global trade move in tandem. Similarly important are shocks to final manufactured goods demand that are amplified by input-output linkages and trade. In the US, foreign shocks that cause higher oil prices – including oil supply disruptions – lead to rising manufacturing relative to services, and higher core inflation and policy rates. This rationalizes, to a large extent, the pattern during major oil price hikes, and, with opposite signs, during important low oil price episodes.