Global oil supply risk and macroeconomic dynamics: Can monetary policy mitigate the risk and welfare loss?

This paper is the first to evaluate the impact of global oil supply risk on the U.S. economy and related monetary policy issues. Utilizing a Structural Vector Autoregressive (SVAR) model with innovative identification strategies alongside a Stochastic Volatility in Mean (SV-in-Mean) model employing Bayesian techniques, we find that oil supply risk precipitates recessions in key macroeconomic indicators, including consumption, investment, output, and employment, while concurrently restricting oil supply and driving up prices. Furthermore, this risk generates inflationary pressures and heightens government debt leverage. To align our empirical observations, we introduce a dynamic general equilibrium model that incorporates global oil supply risk. Through counterfactual simulations, we demonstrate the significant influences of factors such as oil market dynamics, monetary policy decisions, and energy consumption proportions on macro-financial volatility induced by oil supply risk. Additionally, we investigate whether monetary policy should respond to oil supply risk. Our economic assessment and social welfare analysis reveal that this new policy framework mitigates economic downturns while generating heterogeneous welfare effects for households and entrepreneurs, ultimately improving overall social welfare. The insights derived from this research offer useful guidance for policymakers aiming to enhance macro-financial regulation and micro-financial risk management in light of challenges posed by oil supply risk.