Understanding the Estimation of Oil Demand and Oil Supply Elasticities

33 Pages Posted: 28 Feb 2021

See all articles by Lutz Kilian

Lutz Kilian

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

Multiple version iconThere are 4 versions of this paper

Date Written: August 29, 2020

Abstract

This paper examines the advantages and drawbacks of alternative methods of estimating oil supply and oil demand elasticities and of incorporating this information into structural VAR models. I not only summarize the state of the literature, but also draw attention to a number of econometric problems that have been overlooked in this literature. Once these problems are recognized, seemingly conflicting conclusions in the recent literature can be resolved. My analysis reaffirms the conclusion that the one-month oil supply elasticity is close to zero, which implies that oil demand shocks are the dominant driver of the real price of oil. The focus of this paper is not only on correcting some misunderstandings in the recent literature, but on the substantive and methodological insights generated by this exchange, which are of broader interest to applied researchers.

Keywords: Oil supply elasticity, oil demand elasticity, IV estimation, structural VAR, Bayesian inference, oil price, gasoline price.

JEL Classification: Q43, Q41, C36, C52

Suggested Citation

Kilian, Lutz, Understanding the Estimation of Oil Demand and Oil Supply Elasticities (August 29, 2020). CFS Working Paper, No. 649, 2020, Available at SSRN: https://ssrn.com/abstract=3759333 or http://dx.doi.org/10.2139/ssrn.3759333

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

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