The Causal Nexus between Oil Prices, Interest Rates, and Unemployment in Norway Using Wavelet Methods

Abstract

This paper applies wavelet multi-resolution analysis (MRA), combined with two types of causality tests, to investigate causal relationships between three variables: real oil price, real interest rate, and unemployment in Norway. Impulse response functions were also utilised to examine effects of innovation in one variable on the other variables. We found that causal relations between the variables tend to be stronger as the wavelet time scale increases; specifically, there were no causal relationships between the variables at the lowest time scales of one to three months. A causal relationship between unemployment rate and interest rate was observed during the period of two quarters to two years, during which time a feedback mechanism was also detected between unemployment and interest rate. Causal relationships between oil price and both interest rate and unemployment were observed at the longest time scale of eight quarters. In conjunction with Granger causality analysis, impulse response functions showed that unemployment rates in Norway respond negatively to oil price shocks around two years after the shocks occur. As an oil exporting country, increases (or decreases) in oil prices reduce (or increase) unemployment in Norway under a time horizon of about two years; previous studies focused on oil importing economies have generally found the inverse to be true. Unlike most studies in this field, we decomposed the implicit aggregation for all time scales by applying MRA with a focus on the Norwegian economy. Thus, one main contribution of this paper is that we unveil and systematically distinguish the nature of the time-scale dependent relationship between real oil price, real interest rate, and unemployment using wavelet decomposition.