OPEC in world financial markets: Oil prices and interest rates

Abstract

This article examines the relationship between the real rate of interest in world financial markets and the price of oil. If OPEC cannot be viewed as a ‘small’ participant in world financial markets, and should its savings and portfolio behavior differ from that of the rest of the world, then wealth shifts to or from OPEC would affect world interest rates. Subsequently, this paper examines the magnitude of oil price changes required to elicit a significant interest rate change. Our empirical results shed light on OPEC's behavior, which at times may differ from a pure profit maximizing cartel. The short-run price elasticity of the world demand for oil is -0.04 and the long-run elasticity is -0.10. OPEC itself, as expected, faces higher elasticities of -0.08 and -0.36, respectively. The demand elasticity of oil with respect to ‘world’ GNP is 0.8. A major objective of this paper has been to determine the effect of changes in oil prices on world interest rates, and vice versa. Our results imply that only very large oil price increases will have a significant impact on world interest rates. However, oil prices show a non-negligible sensitivity to changes in world interest rates.