Do Oil Shocks Drive Business Cycles? Some U.S. And International Evidence

Oil prices rose sharply prior to the onset of the 2007–2009 recession. Hamilton [in the Palgrave Dictionary of Macroeconomics (2008)] noted that nine of the last ten recessions in the United States were preceded by a substantial increases in the price of oil. In this paper, we consider whether oil price shocks significantly increase the probability of recessions in a number of countries. Because business cycle turning points generally are not available for other countries, we estimate the turning points together with oil's effect in a Markov-switching model with time-varying transition probabilities. We find that, for most countries, oil shocks do affect the likelihood of entering a recession. In particular, for a constant, zero-term spread, an average-sized shock to WTI oil prices increases the probability of recession in the United States by nearly 50 percentage points after one year and nearly 90 percentage points after two years.