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Oil Prices, Exchange Rates and Interest Rates

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  • Kilian, Lutz
  • Zhou, Xiaoqing

Abstract

There has been much interest in the relationship between the price of crude oil, the value of the U.S. dollar, and the U.S. interest rate since the 1980s. For example, the sustained surge in the real price of oil in the 2000s is often attributed to the declining real value of the U.S. dollar as well as low U.S. real interest rates, along with a surge in global real economic activity. Quantifying these effects one at a time is difficult not only because of the close relationship between the interest rate and the exchange rate, but also because demand and supply shocks in the oil market in turn may affect the real value of the dollar and real interest rates. We propose a novel identification strategy for disentangling the causal effects of oil demand and oil supply shocks from the effects of exogenous shocks to the U.S. real interest rate and exogenous shocks to the real value of the U.S. dollar. We empirically evaluate popular views about the role of exogenous real exchange rate shocks in driving the real price of oil, and we examine the extent to which shocks in the global oil market drive the U.S. real exchange rate and U.S. real interest rates. Our evidence for the first time provides direct empirical support for theoretical models of the link between oil prices, exchange rates, and interest rates.

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  • Kilian, Lutz & Zhou, Xiaoqing, 2019. "Oil Prices, Exchange Rates and Interest Rates," CEPR Discussion Papers 13478, C.E.P.R. Discussion Papers.
  • Handle: RePEc:cpr:ceprdp:13478
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    1. Kilian, Lutz & Lee, Thomas K., 2014. "Quantifying the speculative component in the real price of oil: The role of global oil inventories," Journal of International Money and Finance, Elsevier, vol. 42(C), pages 71-87.
    2. Lutz Kilian, 2017. "The Impact of the Fracking Boom on Arab Oil Producers," The Energy Journal, International Association for Energy Economics, vol. 0(Number 6).
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    10. Lutz Kilian & Logan T. Lewis, 2011. "Does the Fed Respond to Oil Price Shocks?," Economic Journal, Royal Economic Society, vol. 121(555), pages 1047-1072, September.
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    12. Clarida, Richard & Gali, Jordi & Gertler, Mark, 1998. "Monetary policy rules in practice Some international evidence," European Economic Review, Elsevier, vol. 42(6), pages 1033-1067, June.
    13. Lutz Kilian & Clara Vega, 2011. "Do Energy Prices Respond to U.S. Macroeconomic News? A Test of the Hypothesis of Predetermined Energy Prices," The Review of Economics and Statistics, MIT Press, vol. 93(2), pages 660-671, May.
    14. Lutz Kilian, 2008. "The Economic Effects of Energy Price Shocks," Journal of Economic Literature, American Economic Association, vol. 46(4), pages 871-909, December.
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    19. Lutz Kilian & Daniel P. Murphy, 2012. "Why Agnostic Sign Restrictions Are Not Enough: Understanding The Dynamics Of Oil Market Var Models," Journal of the European Economic Association, European Economic Association, vol. 10(5), pages 1166-1188, October.
    20. Adonis Yatchew & Joungyeo Angela No, 2001. "Household Gasoline Demand in Canada," Econometrica, Econometric Society, vol. 69(6), pages 1697-1709, November.
    21. Lutz Kilian, 2009. "Not All Oil Price Shocks Are Alike: Disentangling Demand and Supply Shocks in the Crude Oil Market," American Economic Review, American Economic Association, vol. 99(3), pages 1053-1069, June.
    22. Jonas E. Arias & Juan F. Rubio‐Ramírez & Daniel F. Waggoner, 2018. "Inference Based on Structural Vector Autoregressions Identified With Sign and Zero Restrictions: Theory and Applications," Econometrica, Econometric Society, vol. 86(2), pages 685-720, March.
    23. Martin Bodenstein & Luca Guerrieri & Lutz Kilian, 2012. "Monetary Policy Responses to Oil Price Fluctuations," IMF Economic Review, Palgrave Macmillan;International Monetary Fund, vol. 60(4), pages 470-504, December.
    24. Deepa D. Datta & Benjamin K. Johannsen & Hannah Kwon & Robert J. Vigfusson, 2021. "Oil, Equities, and the Zero Lower Bound," American Economic Journal: Macroeconomics, American Economic Association, vol. 13(2), pages 214-253, April.
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    27. Xiaoqing Zhou, 2019. "Refining the Workhorse Oil Market Model," Working Papers 1910, Federal Reserve Bank of Dallas.
    28. Kilian,Lutz & Lütkepohl,Helmut, 2018. "Structural Vector Autoregressive Analysis," Cambridge Books, Cambridge University Press, number 9781107196575, August.
    29. Kilian, Lutz & Zhou, Xiaoqing, 2018. "Structural Interpretation of Vector Autoregressions with Incomplete Information: Revisiting the Role of Oil Supply and Demand Shocks: Comment," CEPR Discussion Papers 13068, C.E.P.R. Discussion Papers.
    30. Marcel Fratzscher & Daniel Schneider & Ine Van Robays, 2013. "Oil Prices, Exchange Rates and Asset Prices," Discussion Papers of DIW Berlin 1302, DIW Berlin, German Institute for Economic Research.
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    32. Xiaoqing Zhou, 2020. "Refining the workhorse oil market model," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 35(1), pages 130-140, January.
    33. Beckmann, Joscha & Czudaj, Robert L. & Arora, Vipin, 2020. "The relationship between oil prices and exchange rates: Revisiting theory and evidence," Energy Economics, Elsevier, vol. 88(C).
    34. Lutz Kilian & Bruce Hicks, 2013. "Did Unexpectedly Strong Economic Growth Cause the Oil Price Shock of 2003–2008?," Journal of Forecasting, John Wiley & Sons, Ltd., vol. 32(5), pages 385-394, August.
    35. Lutz Kilian & Daniel P. Murphy, 2014. "The Role Of Inventories And Speculative Trading In The Global Market For Crude Oil," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 29(3), pages 454-478, April.
    36. Frankel, Jeffrey A & Hardouvelis, Gikas A, 1985. "Commodity Prices, Money Surprises and Fed Credibility," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 17(4), pages 425-438, November.
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    Cited by:

    1. Branko Bošković & Andrew Leach, 2020. "Leave it in the ground? Oil sands development under carbon pricing," Canadian Journal of Economics/Revue canadienne d'économique, John Wiley & Sons, vol. 53(2), pages 526-562, May.
    2. Lian An & Mark A. Wynne & Ren Zhang, 2020. "Shock-Dependent Exchange Rate Pass-Through: Evidence Based on a Narrative Sign Approach," Globalization Institute Working Papers 379, Federal Reserve Bank of Dallas.
    3. Beckmann, Joscha & Czudaj, Robert L. & Arora, Vipin, 2020. "The relationship between oil prices and exchange rates: Revisiting theory and evidence," Energy Economics, Elsevier, vol. 88(C).
    4. Lutz Kilian, 2019. "Facts and Fiction in Oil Market Modeling," CESifo Working Paper Series 7902, CESifo.
    5. Inoue, Atsushi & Kilian, Lutz, 2020. "Joint Bayesian inference about impulse responses in VAR models," CFS Working Paper Series 650, Center for Financial Studies (CFS).
    6. Lutz Kilian & Xiaoqing Zhou, 2020. "Does drawing down the US Strategic Petroleum Reserve help stabilize oil prices?," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 35(6), pages 673-691, September.
    7. Sakib Bin Amin & Noshin Nawal Audry & Ahmed Farah Ulfat, 2021. "The Nexus Between Oil Price Shock and the Exchange Rate in Bangladesh," International Journal of Energy Economics and Policy, Econjournals, vol. 11(2), pages 427-435.
    8. Doga Bilgin & Reinhard Ellwanger, 2019. "The Simple Economics of Global Fuel Consumption," Staff Working Papers 19-35, Bank of Canada.
    9. Khalil, Makram, 2020. "Global oil prices and the macroeconomy: The role of tradeable manufacturing versus nontradeable services," Discussion Papers 60/2020, Deutsche Bundesbank.
    10. Mahadeo, Scott M.R. & Heinlein, Reinhold & Legrenzi, Gabriella D., 2019. "Energy contagion analysis: A new perspective with application to a small petroleum economy," Energy Economics, Elsevier, vol. 80(C), pages 890-903.
    11. Ron Alquist & Reinhard Ellwanger & Jianjian Jin, 2020. "The effect of oil price shocks on asset markets: Evidence from oil inventory news," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 40(8), pages 1212-1230, August.
    12. Maryam Ahmadi & Matteo Manera, 2021. "Oil Price Shocks and Economic Growth in Oil-Exporting Countries," Working Papers 2021.13, Fondazione Eni Enrico Mattei.
    13. Sheng Fang & Paul Egan, 2021. "Tail dependence between oil prices and China's A‐shares: Evidence from firm‐level data," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 26(1), pages 1469-1487, January.
    14. Joscha Beckmann & Mariarosaria Comunale, 2020. "Exchange rate fluctuations and the financial channel in emerging economies," Bank of Lithuania Working Paper Series 83, Bank of Lithuania.
    15. Changyu Liu & Muhammad Abubakr Naeem & Mobeen Ur Rehman & Saqib Farid & Syed Jawad Hussain Shahzad, 2020. "Oil as Hedge, Safe-Haven, and Diversifier for Conventional Currencies," Energies, MDPI, Open Access Journal, vol. 13(17), pages 1-19, August.

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    More about this item

    Keywords

    carry trade; commodity; Exchange rate; global real activity; interest rate; oil price;
    All these keywords.

    JEL classification:

    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
    • Q43 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Energy - - - Energy and the Macroeconomy

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