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Macroeconomic implications of oil price fluctuations: a regime-switching framework for the euro area

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  • Holm-Hadulla, Fédéric
  • Hubrich, Kirstin

Abstract

We investigate whether the response of the macro-economy to oil price shocks undergoes episodic changes. Employing a regime-switching vector autoregressive model we identify two regimes that are characterized by qualitatively different patterns in economic activity and inflation following oil price shocks in the euro area. In the normal regime, oil price shocks trigger only limited and short-lived adjustments in these variables. In the adverse regime, by contrast, oil price shocks are followed by sizeable and sustained macroeconomic fluctuations, with inflation and economic activity moving in the same direction as the oil price. The responses of inflation expectations and wage growth point to second-round effects as a potential driver of the dynamics characterising the adverse regime. The systematic response of monetary policy works against such second-round effects in the adverse regime but is insufficient to fully offset them. The model also delivers (conditional) probabilities for being (staying) in either regime, which may help interpret oil price fluctuations – and inform deliberations on the adequate policy response – in real-time. JEL Classification: E31, E52, C32

Suggested Citation

  • Holm-Hadulla, Fédéric & Hubrich, Kirstin, 2017. "Macroeconomic implications of oil price fluctuations: a regime-switching framework for the euro area," Working Paper Series 2119, European Central Bank.
  • Handle: RePEc:ecb:ecbwps:20172119
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    Cited by:

    1. Shayan Zakipour-Saber, 2019. "State-dependent Monetary Policy Regimes," Working Papers 882, Queen Mary University of London, School of Economics and Finance.
    2. Zakipour-Saber, Shayan, 2019. "State-dependent Monetary Policy Regimes," Research Technical Papers 4/RT/19, Central Bank of Ireland.
    3. Bao H. NGUYEN & OKIMOTO Tatsuyoshi & Trung Duc TRAN, 2019. "Uncertainty-Dependent and Sign-Dependent Effects of Oil Market Shocks," Discussion papers 19042, Research Institute of Economy, Trade and Industry (RIETI).

    More about this item

    Keywords

    inflation; inflation expectations; oil prices; regime switching models; time-varying transition probabilities;

    JEL classification:

    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models

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