Oil, the Economy, and the Stock Market
Joseph H. Davis
The Vanguard Group; National Bureau of Economic Research (NBER)
Roger A Aliaga-Diaz
The Vanguard Group, Inc.
We quantify the time-varying effects of oil-price shocks on the U.S. economy, Federal Reserve policy, and global equity markets. While the first-round impact of oil-price shocks on U.S. economic growth has not changed materially over time, their formerly-negative second-round effects are notably absent over the past 25 years given oil's near-zero impact on long-term inflation expectations. Since oil-price shocks now represent a less-stagflationary policy tradeoff, we show why the Federal Reserve should lower short-term interest rates in response to an oil-price shock under certain (but not all) macro scenarios. For domestic and international stocks, simple regressions reveal the anticipated inverse relationship, with a 10% increase in oil prices associated with a statistically significant 1.5% lower total return. However, the stock market's reaction varies dramatically depending on the source of the oil-price shock, with global stocks - in particular the industrial and materials sectors - responding quite favorably to oil-price increases attributed to global-demand shocks. A key implication is that oil-price increases do not uniformly lead to lower stock returns. Interestingly, our oil-price decomposition suggests that oil's recent surge cannot be explained by supply disruptions, global demand fundamentals, or the depreciation of the U.S. dollar.
Number of Pages in PDF File: 20
Keywords: Oil, macroeconomy, stock market, inflation expectations, Federal Reserve
JEL Classification: E30, E60, G12working papers series
Date posted: May 25, 2008
© 2013 Social Science Electronic Publishing, Inc. All Rights Reserved.
This page was processed by apollo4 in 0.812 seconds