Oil Shocks and the U.S. Economy: Evidence from a FAVAR Model
34 Pages Posted:
Date Written: July 23, 2020
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
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