Oil prices, economic activity and inflation: evidence for some Asian countries

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Abstract

In this paper we study the oil prices–macroeconomy relationship by means of studying the impact of oil price shocks on both economic activity and consumer price indexes for six Asian countries over the period 1975Q1–2002Q2. The results suggest that oil prices have a significant effect on both economic activity and price indexes, although the impact is limited to the short run and more significant when oil price shocks are defined in local currencies. Moreover, we find evidence of asymmetries in the oil prices–macroeconomy relationship for some of the Asian countries.

Introduction

Among the most severe supply shocks hitting the world economies since World War II were sharp increases in the price of oil and other energy products. Oil price shocks receive important consideration for their presumed role on macroeconomic variables.1 They are included in several models such as those of Rasche and Tatom (1981), Bruno and Sachs (1982) and Hamilton (1988). Furthermore, they have been credited with affecting the natural rate of unemployment (e.g., Caruth, Hooker, & Oswald, 1998; Davis & Haltiwanger, 2001; Phelps, 1994), reducing the role of technology shocks in real business cycle models (Davis, 1986) and depressing irreversible investment through their effects on uncertainty (Ferderer, 1996). Thus, from a theoretical point of view, there are different reasons why an oil shock should affect macroeconomic variables, some of them calling for a non-linear specification of the oil price–macroeconomy relationship. For example, the oil shock can lead to lower aggregate demand since the price rise redistributes income between the net oil import and export countries. Second, the oil price increase reduces aggregate supply since higher energy prices mean that firms purchase less energy; consequently, the productivity of any given amount of capital and labor declines and potential output falls. The decline in factor productivity implies that real wages will be lower. If some labor supply is withdrawn voluntarily as a result, potential output will be lower than it would otherwise be, thus compounding the direct impact of lower productivity. Furthermore, it may have a non-linear effect on economic activity if it affects through sectoral reallocations of resources or depressing irreversible investment through their effects on uncertainty (Ferderer, 1996).2

From an empirical point of view, considerable research finds that oil price shocks have affected output and inflation (e.g., Hamilton, 1983, Hamilton, 1988, Hamilton, 1996, Hamilton, 2000, Hooker, 1996, Hooker, 1999, Hooker, 2002, Huntington, 1998; Kahn & Hampton, 1990; Mork, 1989, Mork, 1994, Tatom, 1988). Research also supports the view that these shocks have been an important source of economic fluctuation over the past three decades (Kim & Loungani, 1992).

However, there are various questions which are still far from a consensus. First, empirical evidence shows that oil prices fail to Granger cause macroeconomic variables when data samples are extended past the mid-1980s, due to the nominal price decreases beginning in 1981 and wide swings, following the market collapse in 1985. Several authors argue that this breakdown of the oil prices–macroeconomy relationship reveals that the relation between these variables is non-linear and propose different non-linear specifications of this relation (e.g., Hamilton, 1996; Lee, Ni, & Ratti, 1995).3

Second, and in an international context, an oil shock may have a differential impact on each of the countries due to some variables such as their sectoral composition, their relative position as oil importer or exporter or their differential tax structure.

The main goal of this paper is to analyze the oil price–macroeconomy relationship by means of applying cointegration and Granger causality tests on the oil price-inflation rate and oil price-production growth rate relationships for six Asian countries using quarterly data for the period 1975Q1–2002Q2. In order to account for the possible asymmetry and other type of non-linearities between oil prices and macroeconomic variables, we shall use different transformations of oil price data, each of one suggesting a different channel through which oil prices may affect industrial production levels.

There are several reasons that justify the interest in the energy price and macroeconomic relationship in Asian countries. First, it is becoming more important to understand the macroeconomic behavior in Asian countries, as recognized by the 1997 crises and its impact on other economies. Second, most of the papers on the effect of oil prices are applied to the US case or OECD countries and only a few papers study the Japanese case (Hutchison, 1993; Lee, Lee, & Ratti, 2001; Takenaka, 1991) and other Asian economies (Abeysinghe, 2001). Third, in our sample we include both a net oil exporter (Malaysia) and net oil importers (Japan, Singapore, South Korea, Philippines and Thailand), which could help us to examine whether the oil price–macroeconomy relationship in emerging Asian economies depends on the different net import or export behavior of each country.4

The plan of the paper is as follows. In Section 2 we briefly present the main features on oil price market in order to justify the proxy variables of oil price shocks we use in the empirical analysis. Section 3 covers the empirical analysis and Section 4 provides some concluding remarks.

Section snippets

A first look at oil price data

The choice of oil price variables is difficult and, as we shall show later, important. National oil prices have been influenced by price-controls, high and varying taxes on petroleum products, exchange rate fluctuations (such as the important devaluations after the Asian crisis in most of the countries in our sample) and national price index variations. All the differential characteristics which influence the effective oil price that each of the countries face raise great difficulties in

Empirical analysis

In this section we examine the oil price–macroeconomy relationship, by means of estimating the impact of oil prices on both economic activity and consumer price indexes for some Asian countries during the period 1975Q1–2002Q2.8 The estimation strategy is as

Concluding remarks

This paper analyzes the oil prices–macroeconomy relationship by means of studying the impact of oil price shocks on both inflation and economic growth rates for some Asian countries over the period 1975Q1–2002Q2. Besides the relevance of this analysis in the context of the new oil shock occurred in 2000, the major contribution of this paper is the use of different oil-output and oil-CPI specifications in order to measure the impact of oil prices on both inflation and economic growth rates for

Acknowledgements

The authors gratefully acknowledge the useful comments and suggestions from two anonymous referees. Financial support from the Ministerio de Ciencia y Tecnología (SEC2002-01839, Spain) and Plan de Investigación de la Universidad de Navarra (PIUNA; 2001–2004) is also acknowledged. The usual disclaimer applies.

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