Oil Demand and Supply Shocks in Canada’s Economy

This paper investigates how oil supply shocks, aggregate demand shocks, and speculative oil demand shocks affect Canada’s economy, within an estimated Dynamic Stochastic General Equilibrium (DSGE) model. The estimation is conducted using Bayesian methods, with Canadian quarterly data from 1983Q1 to 2021Q4. The results suggest that the dynamic effects of oil price shocks on Canadian macroeconomic variables vary according to their sources. In particular, a 10 percent increase in the real price of oil driven by positive foreign aggregate demand shocks has a positive effect of about 1.2 percent on Canada’s real GDP upon impact and the effect remains positive over time. In contrast, an increase in the real price of oil driven by negative foreign oil supply shocks or by positive speculative oil demand shocks causes a small effect of about 0.15 percent on Canada’s real GDP upon impact but causes a slightly decline afterwards. At the same time, an oil price increase that originates from aggregate demand shock causes an increase in consumption and investment, while an oil price increase that originates from oil supply shocks or from speculative oil demand shocks cause a decline in consumption and investment. Furthermore, among the identified oil shocks, aggregate demand shocks have been by fare more important in explaining the variations of most of Canadian macroeconomic variables over the estimation period. In contrast, speculative oil demand shock appears to be the first source of variations in real oil price.