Causes and Consequences of Oil Price Shocks on the UK Economy

In this paper, we assess the impact of oil price fluctuations on the UK economy. We use an empirical strategy which allows us to decompose oil price changes from the underlying source of the shock. Our results show that, since the mid-1970s, oil price movements have been mainly associated with shocks to oil demand rather than oil supply. We also find that the consequences of oil price changes on UK macroeconomic aggregates depend on the different types of oil shocks. While increases in global real economic activity do not depress the UK economy in the short run, shortfalls in crude oil supply cause an immediate fall in GDP growth. In addition, since monetary policy depends on the nature of the shock hitting the oil market, domestic inflation increases following a rise in the real oil price. Finally, our results also show that in response to oil price increases, the government deficit decreases.