Oil Shocks and the U.S. Economy: Evidence from a FAVAR Model

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See all articles by Kuhelika De

Kuhelika De

Grand Valley State University - Department of Economics

Ryan A. Compton

University of Manitoba

Daniel Giedeman

Grand Valley State University - Department of Economics

Date Written: July 23, 2020

Abstract

We investigate the economic effects of three separate types of oil price shocks on the U.S. economy using a factor augmented vector autoregression framework and 185 monthly macroeconomic indicators from 1978 to 2017. We find that while increases in the price of crude oil triggered by oil supply shocks and oil demand shocks lead to a significant and permanent increase in the U.S. price level, the main drivers of fluctuations in the price of crude oil and the U.S. price level are oil-specific precautionary demand shocks. Further, while increases in the price of oil triggered by oil supply shocks are recessionary and lower U.S. economic activity, those triggered by oil demand shocks driven by global economic activity are associated with increased U.S. economic activity. We also find evidence that monetary policy-makers tighten monetary policy in response to oil demand shocks to mitigate inflationary effects, however we find no such evidence for oil supply shocks. Finally, we find the U.S. dollar real exchange rate depreciates in response to increases in the price of oil caused by both oil demand and supply shocks, however the effects from oil supply shocks are more permanent.

Keywords: Oil Demand Shocks, Oil Supply Shocks, Oil Price, Monetary Policy, Exchange Rate, Factor Model, FAVAR

JEL Classification: C32, E31, E44, E52, F41, Q4

Suggested Citation

De, Kuhelika and Compton, Ryan A. and Giedeman, Daniel, Oil Shocks and the U.S. Economy: Evidence from a FAVAR Model (July 23, 2020). Available at SSRN: https://ssrn.com/abstract=

Kuhelika De (Contact Author)

Grand Valley State University - Department of Economics ( email )

3072 L. William Seidman Center
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Grand Rapids, MI 49504
United States
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Ryan A. Compton

University of Manitoba ( email )

501 F.A. Bldg
Winnipeg R3T 5V4, Manitoba R3T 5V5
Canada

Daniel Giedeman

Grand Valley State University - Department of Economics ( email )

478c DeVos Center
Grand Rapids, MI 49504
United States

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