Oil Prices and Global Activity in a General Equilibrium Model with Dynamic Elasticities

This paper develops a dynamic general equilibrium model of the global crude oil market that delivers horizon-dependent price elasticities of oil supply and demand, arising from the gradual adjustment of oil producers and consumers over time. We refer to elasticities beyond the impact horizon as dynamic elasticities. We derive closed-form expressions for the elasticities, which allow us to impose transparent prior restrictions in the empirical analysis and to quantify how dynamic elasticities shape the propagation of structural shocks to oil prices and global real activity. We estimate the model with Bayesian methods using monthly data on industrial production and key oil-market indicators — production, inventories, and prices. Diffuse priors on dynamic elasticities imply elasticity profiles that are essentially flat across horizons. By contrast, informative priors — or an expanded information set including drilling activity under diffuse elasticity priors — yield elasticities that rise with the horizon, increase the contribution of supply shocks to fluctuations in oil prices and real activity, and reduce that of oil-consumption demand shocks.