The effects of oil price uncertainty on China’s economy

Abstract

This paper studies the effects of world oil price uncertainty on China’s economy from both empirical and theoretical angles. First, we use a vector autoregression model with stochastic volatility in mean to explore the relation between world oil price uncertainty and real economic activity of China. We find that one standard deviation higher uncertainty shock of world oil price reduces electricity production by almost 0.2 percentage. Then we use a canonical New-Keynesian model solved by third-order perturbation method to explain this phenomenon, in which households’ precautionary saving channel distresses real activity when oil price uncertainty is higher.