28 Pages Posted: 11 Jul 2016
Date Written: July 3, 2016
The recent plunge in oil prices has brought into question the generally accepted view that lower oil prices are good for the US and the global economy. In this paper, using a quarterly multi-country econometric model, we first show that a fall in oil prices tends relatively quickly to lower interest rates and inflation in most countries, and increase global real equity prices. The effects on real output are positive, although they take longer to materialize (around 4 quarters after the shock). We then re-examine the effects of low oil prices on the US economy over different sub-periods using monthly observations on real oil prices, real equity prices and real dividends. We confirm the perverse positive relationship between oil and equity prices over the period since the 2008 financial crisis highlighted in the recent literature, but show that this relationship has been unstable when considered over the longer time period of 1946-2016. In contrast, we find a stable negative relationship between oil prices and real dividends which we argue is a better proxy for economic activity (as compared to equity prices). On the supply side, the effects of lower oil prices differ widely across the different oil producers, and could be perverse initially, as some of the major oil producers try to compensate their loss of revenues by raising production. Taking demand and supply adjustments to oil price changes as a whole, we conclude that oil markets equilibrate but rather slowly, with large episodic swings between low and high oil prices.
Keywords: Oil prices, equity prices, dividends, economic growth, oil supply, global oil markets, and international business cycle.
JEL Classification: C32, E17, E32, F44, F47, O51, Q43.
Suggested Citation: Suggested Citation
Mohaddes, Kamiar and Pesaran, M. Hashem, Oil Prices and the Global Economy: Is it Different this Time Around? (July 3, 2016). USC-INET Research Paper No. 16-21. Available at SSRN: https://ssrn.com/abstract=2808084