Welfare Costs of Oil Price Shocks

Abstract

This paper investigates the welfare costs oil price shocks for 35 countries. The empirical investigation is based on a structural vector autoregression model, where oil price pass-through into consumer prices for each country is estimated as the cumulative response of inflation divided by the cumulative response of oil prices, both following oil price shocks. To investigate the welfare costs of these oil price shocks, a dynamic general equilibrium model is introduced, where its parameters are optimized for each country to match the empirical oil price pass-through estimates. The corresponding results suggest that the welfare costs of oil price shocks increase across countries with oil dependency, monetary policy reaction to inflation, and intertemporal elasticity of substitution measures. Counterfactual analyses further show that reducing monetary policy reaction to inflation, reducing oil dependency, and reducing intertemporal elasticity of substitution by the corresponding policies would mitigate the welfare costs of oil price shocks.

Keywords: Welfare, Policy, Oil Price, Dynamic General Equilibrium Model

JEL Classification: C32, E31, E52, E58, F41, F62