Identification of Expectational Shocks in the Oil Market using OPEC Announcements

Surprises in the price of oil futures computed on the day of OPEC announcements have been used as an exogenous measure of shifts in market beliefs about future oil supply to identify shocks to oil supply expectations. I show that these surprises capture not only revisions in market expectations about oil supply, but also revisions in expectations about oil demand. This con ation of supply and demand components invalidates the use of the surprises as an exogenous measure of shocks to oil supply expectations. I show that imposing an additional restriction on the sign of the co-movement between surprises in oil futures and changes in stock prices within the day of the OPEC announcement disentangles the two underlying shocks. Accordingly, I derive two robust instruments for the identification of shocks to oil supply and demand expectations that combine the surprises with this additional sign restriction, and I test them on a set of empirical specifications modelling the oil market and the global economy. A negative shock to oil supply expectations has deep and long-lasting stag ationary e ects on global economic conditions that are stronger and more immediate than previously reported. These effects represent a challenge for monetary authorities that seek to stabilise both prices and output. I show that information effects are a prominent feature of the oil market and need to be accounted for when estimating the effects of shocks to oil supply expectations.