Exogenous Oil Supply Shocks: How Big are They and How Much Do They Matter for the Us Economy?

64 Pages Posted: 10 Aug 2005

See all articles by Lutz Kilian

Lutz Kilian

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

Date Written: July 2005


Since the oil crises of the 1970s there has been strong interest in the question of how oil production shortfalls caused by wars and other exogenous political events in OPEC countries affect oil prices, US real GDP growth and US CPI inflation. This study focuses on the modern OPEC period since 1973. The results differ along a number of dimensions from the conventional wisdom. First, it is shown that under reasonable assumptions the timing, magnitude and even the sign of exogenous oil supply shocks may differ greatly from current state-of-the-art estimates. Second, the common view that the case for the exogeneity of at least the major oil price shocks is strong is supported by the data for the 1980/81 and 1990/91 oil price shocks, but not for other oil price shocks. Notably, statistical measures of the net oil price increase relative to the recent past do not represent the exogenous component of oil prices. In fact, only a small fraction of the observed oil price increases during crisis periods can be attributed to exogenous oil production disruptions. Third, compared to previous indirect estimates of the effects of exogenous supply disruptions on real GDP growth that treated major oil price increases as exogenous, the direct estimates obtained in this paper suggest a sharp drop after five quarters rather than an immediate and sustained reduction in economic growth for a year. They also suggest a spike in CPI inflation three quarters after the exogenous oil supply shock rather than a sustained increase in inflation, as is sometimes conjectured. Finally, the results of this paper put into perspective the importance of exogenous oil production shortfalls in the Middle East. It is shown that exogenous oil supply shocks made remarkably little difference overall for the evolution of US real GDP growth and CPI inflation since the 1970s, although they did matter for some historical episodes.

Keywords: Counterfactual, economic activity, exogeneity, inflation, oil shock, oil supply, war, weak instruments

JEL Classification: C32, E32

Suggested Citation

Kilian, Lutz, Exogenous Oil Supply Shocks: How Big are They and How Much Do They Matter for the Us Economy? (July 2005). CEPR Discussion Paper No. 5131, Available at SSRN: https://ssrn.com/abstract=781484

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) ( email )

United Kingdom