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Not All Oil Price Shocks Are Alike: Disentangling Demand and Supply Shocks in the Crude Oil Market

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  • Kilian, Lutz

Abstract

Using a newly developed measure of global real economic activity, a structural decomposition of the real price of crude oil in four components is proposed: oil supply shocks driven by political events in OPEC countries; other oil supply shocks; aggregate shocks to the demand for industrial commodities; and demand shocks that are specific to the crude oil market. The latter shock is designed to capture shifts in the price of oil driven by higher precautionary demand associated with concerns about the availability of future oil supplies. The paper quantifies the magnitude and timing of these shocks, their dynamic effects on the real price of oil and their relative importance in determining the real price of oil during 1975-2005. The analysis also sheds light on the origins of the major oil price shocks since 1979. Distinguishing between the sources of higher oil prices is shown to be crucial for assessing the effect of higher oil prices on U.S. real GDP and CPI inflation. It is shown that policies aimed at dealing with higher oil prices must take careful account of the origins of higher oil prices. The paper also quantifies the extent to which the macroeconomic performance of the U.S. since the mid-1970s has been determined by the external economic shocks driving the real price of oil as opposed to domestic economic factors and policies.

Suggested Citation

  • Kilian, Lutz, 2006. "Not All Oil Price Shocks Are Alike: Disentangling Demand and Supply Shocks in the Crude Oil Market," CEPR Discussion Papers 5994, C.E.P.R. Discussion Papers.
  • Handle: RePEc:cpr:ceprdp:5994
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    References listed on IDEAS

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    1. Goncalves, Silvia & Kilian, Lutz, 2004. "Bootstrapping autoregressions with conditional heteroskedasticity of unknown form," Journal of Econometrics, Elsevier, vol. 123(1), pages 89-120, November.
    2. Hamilton, James D., 2003. "What is an oil shock?," Journal of Econometrics, Elsevier, vol. 113(2), pages 363-398, April.
    3. den Haan, Wouter J., 2000. "The comovement between output and prices," Journal of Monetary Economics, Elsevier, vol. 46(1), pages 3-30, August.
    4. den Haan, Wouter J. & Sumner, Steven W., 2004. "The comovement between real activity and prices in the G7," European Economic Review, Elsevier, vol. 48(6), pages 1333-1347, December.
    5. Lutz Kilian, 2008. "Exogenous Oil Supply Shocks: How Big Are They and How Much Do They Matter for the U.S. Economy?," The Review of Economics and Statistics, MIT Press, vol. 90(2), pages 216-240, May.
    6. Cooley, Thomas F. & Leroy, Stephen F., 1985. "Atheoretical macroeconometrics: A critique," Journal of Monetary Economics, Elsevier, vol. 16(3), pages 283-308, November.
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    More about this item

    Keywords

    oil supply; causality; oil demand; oil price shocks;
    All these keywords.

    JEL classification:

    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • Q43 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Energy - - - Energy and the Macroeconomy

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