Abstract
This note combines and distills existing and new research to inform discussion on the topical policy issue of oil prices. Following four years of relative stability at around $105 per barrel (bbl), oil prices have declined sharply since June 2014 and are expected to remain low for a considerable period of time. The drop in prices likely marks the end of the commodity supercycle that began in the early 2000s. Since the past episodes of such sharp declines coincided with substantial fluctuations in activity and inflation, the causes and consequences of and policy responses to the recent plunge in oil prices have led to intensive debates. This paper addresses four questions at the center of these debates, with particular emphasis on emerging market and developing economies: 1) How does the recent decline in oil prices compare with previous episodes? 2) What are the causes of the sharp drop and what is the outlook for oil price? 3) What are the economic and financial consequences? 4) What are the main policy implications? The decline in oil prices will lead to significant real income shifts from oil exporters to oil importers, likely resulting in a net positive effect for global activity over the medium term. However, several factors could counteract the global growth and inflation implications of the lower oil prices. These include weak global demand and limited scope for additional monetary policy easing in many countries. The disinflationary implications of falling oil prices may be muted by sharp adjustments in currencies and effects of taxes, subsidies, and regulations on prices. Regarding fiscal policy, the loss in oil revenues for exporters will strain public finances, while savings among oil importers could help rebuild fiscal space. Lower oil prices also present a window of opportunity to implement structural reforms. These include, in particular, comprehensive and lasting reforms of fuel subsidies, as well as energy taxes more broadly.
Highlights
Several factors could counteract its impact on global growth and inflation,thedropinoilpriceswillposesignificantchallengesformonetary,fiscal,andstructuralpolicies
VARmodelsincludeyearͲonͲyeargrowthinconsumerprices,oilprices(inlocalcurrency),thenominaleffective exchangerateandthedeviationofindustrialproductionfromitsHodrickͲPrescottͲfilteredtrend.Modelswere estimatedwith8lags(basedonaselectionofinformationcriteria)andimpulseresponsesderivedfromaCholesky decomposition,withCPIinflationlastintheorderingandthereforeaffectedcontemporaneouslybyshockstoall othervariables.TheorderingoftheVARisasfollowing:oilpriceinlocalcurrency,thedeviationofindustrial production,nominaleffectiveexchangerateandinflation.TheselectionofinformationcriteriareferstoAkaike informationcriterionandfinalpredictionerror
Summary
ThecumulativeoilpricedeclinebetweenJune2014andJanuary2015wasthethirdlargestofthepast years(whenoilbegantradinginfuturesexchanges)andwasdrivenbya“perfectstorm”ofconditions thatexertedstrongdownwardpressureonprices.Althoughchangesinsupplyanddemandexpectations playedakeyrole,theserevisionswereneitheruniquenorunusuallylarge.,theycoincidedwith threeothermajordevelopments:asignificantshiftinOPEC’spolicyobjectives,lessͲthanͲexpected spilloversfromgeopoliticalrisks,andasignificantappreciationoftheU.S.dollar.Empiricalestimates suggestthatsupply(muchmorethandemand)factorshaveaccountedforthelion’sshareofthelatest plungeinoilprices.Sincebothsupplyanddemandrelatedfactorsunderlyingtherecentdeclineinoil pricesareexpectedtopersistoverthenearͲtomediumͲterm,oilpricesarelikelytoremainsoftbut volatile,withagradualrecoveryoverthenextdecade. Sustainedlowoilpricesarelikelytohavesignificantimplicationsforgrowthandinflation.Ifdrivenlargely bysupplyfactors,historicalestimatessuggestthatthe45percentdeclineinoilprices—ascurrently expectedfor2015onanannualaveragebasis—wouldlikelyliftglobalGDPbyupto0.7Ͳ0.8percentover themediumtermandreduceglobalinflationbyafullpercentagepointintheshortterm.severalfactorsmaychangetheeffectsongrowthandinflation.Weakglobaldemandandacutepressures onoilexporters,combinedwithlingeringpostͲcrisisuncertaintiesandpolicychallengesamonglarge importers,couldlimitsomeoftheexpectedbenefitsfortheglobaleconomyintheshortͲterm.Sharp currencyadjustments,varyingtaxes,subsidiesorotherpriceregulationscouldimplydifferenteffectson inflationpatternsacrosscountries. InoilͲimportingdevelopingeconomies,thedeclineinoilpricesshouldsupportstrongergrowth,reduce inflation,andimproveexternalandfiscalbalances,whichshouldlowermacroeconomicvulnerabilitiesand, ,widenpolicyroom.Incontrast,growthinoilͲexportingeconomieswilllikelybe negativelyaffected,asloweroilpricescausesignificantlossesinexportandfiscalrevenues.A precipitousadjustmentinoilͲexportingcountriescouldbeforcedbysuddenreassessmentofcredit andsovereignrisksbyinvestorsandmademoredifficultbylimitedsectoraldiversification.The sharpdeclineinoilpriceshasalreadybeenaccompaniedbysubstantialcapitaloutflows,reserve losses,andsharpdepreciationsinsomeoilexporters,withpotentiallynegativecrossͲborder spillovereffects. Loweroilpriceswillhavesignificantimplicationsformonetaryandfiscalpolicies.InoilͲimporting countries,declininginflationandcurrentaccountimprovementscouldallowcentralbanksto maintainaccommodativepolicies.IntheEuroAreaandJapan,,disinflationislessan opportunitythanachallenge:sinceinflationisalreadyuncomfortablylow,furtherdisinflation risksdeͲanchoringinflationexpectationsandcallsforadditionalmonetarystimulus.Loweroil pricescouldalsoprovideadditionalfiscalspacethatcouldbeusedtostimulateactivityif needed.InoilͲexportingcountries,theroomformaneuverwillbemorelimited.Centralbanksin thosecountrieswillhavetobalancetheneedtosupportgrowthagainsttheneedtomaintain stableinflationandinvestorconfidence.Inmostcases,fiscalpolicywillhavetobetightenedto makeupforthelossofoilͲrelatedrevenues. Comparedtopreviousepisodesofpricedeclinesduringthepast30years,thefallinoilprices betweenJune2014andJanuary2015isasignificantbutnotunprecedentedevent(Figure).Five otherepisodesofoilpricedeclinesof30percentormoreinasevenͲmonthperiodoccurredsince tradinginfuturesexchangesstartedin1984.Thesecoincidedwithmajorchangesintheglobal economyandoilmarkets.Thefirstone,in1985Ͳ86,wasmostlyassociatedwithasignificantshiftin OPECpolicy,whilesubsequentepisodeswereprimarilydrivenbyweakeningglobaldemand followingU.S.recessions(1990–91and2001);theAsiancrisis(1997–98);andtheglobalfinancial crisis(2008Ͳ09).Thelatestepisode(June2014ͲJanuary2015)constitutesthethirdlargestprice drop,onlysurpassedbythepricecollapsesin2008andin1985Ͳ86. X Rapidgrowthinunconventionaloil.Inmanyrespects,therecentoilboomfrom unconventionalsourcesresemblestheexpansionofoilsupplyfromtheNorthSeaandthe GulfofMexicointhe1970sandearly1980s.Thetechnologytoextractoilfromtheseahad beenavailablebutthehighoilpricesofthe1970smadetheuseofsuchtechnology profitable.During1973Ͳ83,NorthSeaandtheGulfofMexicotogetheraddedsome6mb/d addedsome6mb/dtoglobalmarkets—asmuchasunconventionalsourcesaddedtothe globaloilmarketduring2004Ͳ14. X ChangeinOPECpolicy.OPEC’sdecisiontoabandonpricetargetinginNovember2014also hasimportantsimilaritiestoitsactionsduringthe1985Ͳ86episode.Followingthe1979peakin oilprices,OPECreduceditssupplytomaintainhighprices.Upholdingitspricetargetnecessitated thecartelslashingitsoilsupplyoverthefollowingsixyears,from30mb/din1979to16mb/din 1985.,despitesuchadrasticsupplycut,realoilpricesdeclined20percentduringthis period.Inresponse,OPECbeganincreasingsupplies(to18mb/dbyDecember1985from13.7 mb/dinJune1985).Partlybecauseofthispolicychange,oilpricescollapsedandremainedlow foralmosttwodecades(WorldBank,2009).Inresponsetothenewlowsinpricesreachedafter theEastAsianfinancialcrisis,OPECstartedsettingatargetpricerangeof$25Ͳ35/bbl.Therange waschangedto$100Ͳ110/bblbeforethe2008financialcrisis. Asaresultofasevereglobalrecession(withmostrecoveringjustasquicklyafterward).3Otherprice andmarketdevelopmentsalsosuggestthattherecentepisodewasdrivenbyarangeofmostly sectoralfactors,whereasthe2008Ͳ09episodewasduetocommonfactors—aseverecollapsein demandfollowingtheglobalfinancialcrisis,globaluncertaintyandliquidityconstraints.First, returnsinfuturesmarketsforoilwerelesscorrelatedwiththoseforothercommoditiesinlate 2014thanin2008Ͳ09.Second,dailyoilpricechangesarelesscorrelatedwithglobalequityreturns duringthelatestepisodethantheywereduringtheglobalfinancialcrisis. ThedeclineinoilpricessincemidͲ2014waspartlyacatchinguptoabroadertrendofcommodity pricedeclinesthathadbeenwellunderway.Afterreachingdeeplowsduringtheglobalfinancial crisis,mostcommodityprices,includingoilprices,peakedinthefirstquarterof2011.Sincethen, pricesofmetals,agriculturalandrawmaterialshavedeclinedsteadilyasaresultofweakglobal demandandrobustsupplies.Incontrast,oilpricesfluctuatedwithinanarrowbandaround $105/barrel(bbl)untilJune2014.Throughmuchof2012and2013,theimpactofsofteningglobal demandonoilmarketswasoffsetbyconcernsaboutgeopoliticalrisksandpricingpoliciesexercised byOPEC.Assomeofthesefactorsunwound,oilpricestartedtodropsteeplyinJune2014.By February2015,thecumulativefallinoilpriceswassignificantlylargerthanthatinothercommodity pricessincetheirpeaksin2011.
Sign-in/Register to view highlights & summary Sign-in/Register to access full text options 
Free) 
Talk to us
Join us for a 30 min session where you can share your feedback and ask us any queries you have
Schedule a call
