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Oil Prices and the Global Economy: Is it Different this Time Around?

28 Pages Posted: 11 Jul 2016  

Kamiar Mohaddes

University of Cambridge - Faculty of Economics and Politics; University of Cambridge - Girton College

M. Hashem Pesaran

USC Dornsife Institute for New Economic Thinking; University of Southern California; Trinity College, Cambridge

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Date Written: July 3, 2016

Abstract

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

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

Kamiar Mohaddes (Contact Author)

University of Cambridge - Faculty of Economics and Politics ( email )

Austin Robinson Building
Sidgwick Avenue
Cambridge, CB3 9DD
United Kingdom
+44 (0) 1223338904 (Phone)

HOME PAGE: http://people.ds.cam.ac.uk/km418

University of Cambridge - Girton College ( email )

Cambridge, CB3 0JG
United Kingdom
+44 (0)1223 338999 (Phone)
+44 (0)1223 338896 (Fax)

HOME PAGE: http://people.ds.cam.ac.uk/km418

M. Hashem Pesaran

USC Dornsife Institute for New Economic Thinking ( email )

3620 S. Vermont Avenue, KAP 364F
Los Angeles, CA 90089-0253
United States

University of Southern California ( email )

Los Angeles, CA 90089
United States

Trinity College, Cambridge ( email )

United Kingdom

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