The asymmetric effects of oil shocks on output growth: A Markov–Switching analysis for the G-7 countries

Abstract

Oil shocks are generally acknowledged to have important effects on both economic activity and macroeconomic policy. The aim of this paper is to investigate how oil price shocks affect the growth rate of output of a subset of developed countries by comparing alternative regime switching models. Different Markov–Switching (MS) regime autoregressive models are, therefore, specified and estimated. In a successive step, univariate MS models are extended in order to verify if the inclusion of asymmetric oil shocks as an exogenous variable improves the ability of each specification to identify the different phases of the business cycle for each country under scrutiny. Following the wide literature on this topic, seven different definitions of oil shocks which are able to describe oil price changes, asymmetric transformations of oil price changes, oil price volatility, and oil supply conditions are considered. Our findings can be summarized as follows. While the introduction of different oil shock specifications is never rejected, positive oil price changes, net oil price increases and oil price volatility are the oil shock definitions which contribute to a better description of the impact of oil on output growth. In addition, models with exogenous oil variables generally outperform the corresponding univariate specifications which exclude oil from the analysis. However, a stability analysis of the coefficients across different subsamples shows that the role of oil shocks in explaining recessionary episodes has changed over time. Improvements in energy efficiency, together with a better systematic approach to external supply and demand shocks by monetary and fiscal authorities are argued to be responsible for the changing macroeconomic effects of oil shocks. Finally, the impact of G-7 countries aggregate growth on oil market conditions is considered and assessed empirically. The null hypothesis of the absence of a reverse relationship from real GDP growth to oil prices is rejected by the data.