Oil Prices, Exchange Rates and Interest Rates

56 Pages Posted: 21 Feb 2019

See all articles by Lutz Kilian

Lutz Kilian

Federal Reserve Banks - Federal Reserve Bank of Dallas; Centre for Economic Policy Research (CEPR)

Beata Smarzynska Javorcik

University of Oxford - Department of Economics

Multiple version iconThere are 4 versions of this paper

Date Written: 2019

Abstract

There has been much interest in the relationship between the price of crude oil, the value of the U.S. dollar, and the U.S. interest rate since the 1980s. For example, the sustained surge in the real price of oil in the 2000s is often attributed to the declining real value of the U.S. dollar as well as low U.S. real interest rates, along with a surge in global real economic activity. Quantifying these effects one at a time is difficult not only because of the close relationship between the interest rate and the exchange rate, but also because demand and supply shocks in the oil market in turn may affect the real value of the dollar and real interest rates. We propose a novel identification strategy for disentangling the causal effects of oil demand and oil supply shocks from the effects of exogenous shocks to the U.S. real interest rate and exogenous shocks to the real value of the U.S. dollar. We empirically evaluate popular views about the role of exogenous real exchange rate shocks in driving the real price of oil, and we examine the extent to which shocks in the global oil market drive the U.S. real exchange rate and U.S. real interest rates. Our evidence for the first time provides direct empirical support for theoretical models of the link between oil prices, exchange rates, and interest rates.

Keywords: exchange rate, interest rate, oil price, global real activity, commodity, carry trade

JEL Classification: E430, F310, F410, Q430

Suggested Citation

Kilian, Lutz and Smarzynska Javorcik, Beata, Oil Prices, Exchange Rates and Interest Rates (2019). CESifo Working Paper No. 7484, Available at SSRN: https://ssrn.com/abstract=3338839

Lutz Kilian (Contact Author)

Federal Reserve Banks - Federal Reserve Bank of Dallas ( email )

2200 North Pearl Street
PO Box 655906
Dallas, TX 75265-5906
United States

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Beata Smarzynska Javorcik

University of Oxford - Department of Economics ( email )

Manor Road Building
Manor Road
Oxford, OX1 3BJ
United Kingdom

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