Which Side of the Economy Is Affected More by Oil Prices: Supply or Demand?
18 Pages Posted: 2 Oct 2013
Date Written: September 30, 2013
This paper develops a New-Keynesian model to examine a theoretical global economy with two basic macroeconomic components: An energy producer and an energy consumer. This simple economy uses these two components to evaluate how oil prices affect the consumer economy’s GDP and inflation over the period 1960-2011. This model assumes that changes in the oil price transfer to macro variables through either supply or demand channels. In order to examine the effects of this transfer, an IS curve is used to look at the demand side and a Phillips curve is used to analyze inflationary effects from the supply side, along with any effects that could hinder economic growth. Using this theoretical framework as a base makes it possible to conduct an empirical analysis of the supply and demand channels. This analysis concludes that movements in the oil price mainly affect the economy through the demand side by reducing household expenditures and energy consumption. Additionally, this analysis provides several additional findings, among which are the relationship between expansionary monetary policies and heightened oil prices, the demand side’s elasticities (price and income), and the supply side’s price elasticity.
Keywords: Oil prices, New-Keynesian model, monetary policies, interest rate
Suggested Citation: Suggested Citation