Identifying Fundamental and Financial Factors Underlying Oil Price Movements

Abstract:     
This paper examines the relative importance of various financial and real shocks underlying oil price fluctuations using alternative Bayesian VAR approaches to calibrate the nature of major shocks. With a view to understanding the time-varying nature of shocks and structural shifts in their persistence, the models are estimated for two sub-periods. Contrary to some empirical findings, we find limited support for the argument that monetary policy shocks played an important role in causing fluctuations in oil prices. We also find evidence of significant but short-run effect of supply shocks on oil prices, whereas demand shocks seem to play a major role in driving oil prices in the medium to long-run. Precautionary oil demand shocks including speculation in commodity markets seem to have strong short-run impact on oil prices. Contrary to the belief held by some, demand shocks have now emerged as key drivers of oil prices over the medium to long-run. The findings do not, however, completely ignore the indirect role played by financial factors including short-term interest rates in causing fluctuations in oil prices by way of stimulating aggregate demand.

Number of Pages in PDF File: 35

Keywords: oil prices, monetary policy, bayesian VAR

JEL Classification: E3, E52, C11

working papers series