Monetary Policy and the Oil Market

The price of oil more than halved in less than 5 months since September 2014, after nearly 5 years of stability. This chapter analyzes the reasons behind the recent drop in oil prices in both the demand and supply side of the oil market. Specifically, it sheds light on one of the most important reasons in the demand side, which is coming from the monetary policy that has been neglected in most interpretations. The authors of this chapter in their earlier research (Yoshino and Taghizadeh-Hesary, Int J Monet Econ Finance 7(3):157–174, 2014) found that this latter reason had significant impact in inflating the price of oil in 2009 following the subprime mortgage crisis when the world economy was in recession. By the easy monetary policy of the United States (US) and some other developed economies following the crisis, in early 2009 a large amount of liquidity entered into the oil market, since the developed economies were in recession, so they need a safe place in which to invest. In 2014 and 2015, following the recovery of the US economy and especially its capital market, liquidities that had moved from the disordered developed economies’ capital markets to oil and commodities markets during the global financial crisis of 2008–2009 in order to keep their real values, are coming back to capital markets, hence it reduced the global oil demand sharply which pushed the oil prices down.

While the oil price shocks of the 1970s can be explained by pure supply factors, starting in the 1980s oil prices increasingly began to come under a different type of pressure. Oil prices accelerated from about $35 per barrel in 1981 to beyond $111 per barrel in 2011. At the same time interest rates subsided from 16.7 % per annum to about 0.1 %. This chapter explains how this long-term price increase in most cases, was caused by expansionary monetary policies that heightened oil prices through interest rate channels. Aggressive monetary policies stimulated oil demand and blew up oil prices, a trend that led to slower economic growth. As for elasticities the results described in this chapter show that demand is price elastic and, unlike some earlier literature states, it is significantly elastic to income too. In the last section, the results show that oil prices adjust instantly, declaring the existence of equilibrium in the oil market during the period from 1960 to 2011.

This chapter develops a New Keynesian model to examine a theoretical global economy with two basic macroeconomic components: an energy producer and an energy consumer. (From now on in this chapter whenever we refer to the “energy” or “energy prices”, we refer to “crude oil” and “crude oil price”, which is the main source of energy.) This simple economy uses these two components to evaluate how oil prices affect the consumer economy’s gross domestic product and inflation from 1960 to 2011. This model assumes that changes in the oil price transfer to macro variables through either supply (aggregate supply curve) or demand channels (aggregate demand curve). In order to examine the effects of this transfer, an IS curve is used to look at the demand side and a Phillips curve is used to analyze inflationary effects from the supply side. The empirical analysis concludes that movements in the oil price mainly affect the economy through the demand side (shifting the aggregate demand curve) by affecting household expenditures and energy consumption. This analysis provides several additional findings, among which is that easy monetary policies amplify energy demand more than supply, resulting in skyrocketing crude oil prices, which inhibit economic growth.

This research examines how monetary policy has affected crude oil prices after the subprime mortgage crisis. Our earlier research (Taghizadeh-Hesary F, Yoshino N, OPEC Energy Rev 38(1):1–20, 2014) found a significant impact of easy monetary policy on energy prices from 1980 to 2011. This chapter reports that the quantitative easing of United States (US) monetary policies weakened the US dollar by shifting US investors to invest in the oil market and other commodity markets. An empirical analysis shows that the weaker exchange rate of the dollar pushed up the oil price in 2009–2012, while world gross domestic product was not significant at all since the global economy was in a recession in that period. This trend had the effect of imposing a longer recovery time on the global economy, as oil has been shown to be one of the most important production inputs.

This chapter assess the impact of crude oil price movements on two macroeconomic variables—gross domestic product (GDP) growth rate and the consumer price index inflation rate—in three economies: the United States and Japan (developed economies) and the People’s Republic of China (PRC) (emerging economy). These economies were chosen for this research because they are the world’s three largest oil consumers. The main objective of this research is to see whether these economies are still reactive to oil price movements. The results obtained suggest that the impact of oil price fluctuations on developed oil importers’ GDP growth is much milder than on the GDP growth of an emerging economy. On the other hand, however, the impact of oil price fluctuations on the PRC’s inflation rate was found to be milder than in the two developed economies that were examined.

Japan has reached the limits of conventional macroeconomic policies. Recently, the Bank of Japan, in order to overcome the deflation and achieve sustainable economic growth, set the inflation target at 2 % and implemented aggressive monetary policy to achieve this target as soon as possible. Although prices started to rise after the Bank of Japan implemented monetary easing, the main reason for this price elevation may not come directly from easy monetary policy, but other sources such as higher oil prices. High oil prices in yen, which is the result of a depreciated yen, is one of the main causes of the inflation. Moreover, this chapter shows that quantitative easing may not stimulate the Japanese economy. Aggregate demand that includes private investment did not increase significantly in Japan when the interest rate was lowered. Private investment displays this unconventional behavior because of uncertainty about the future and the aging population. We believe that the remedy for the Japanese economy is not monetary policy. The government needs to look for serious structural changes and growth strategies.

This research evaluates the impact of oil price shocks on oil producing and consuming economies; we used a simultaneous equation framework for different economies with business relations. As expected, we found that oil producers (in this study, Iran and the Russian Federation) benefit from oil price shocks. However contrary to previous findings, they also benefit from the indirect effect through their trade partners. For oil-consuming economies, the effects are more diverse. In some economies, output falls in response to an oil price shock, while some others seem to be immune. Generally, those economies that trade more with oil producers gain indirect benefits via higher demand from oil producers. For instance, the Netherlands, Germany, France, Italy, the United States, the United Kingdom, and the People’s Republic of China get negative direct effects and positive indirect effects from oil producing economies. This is exactly the result that we anticipated. India has both negative effects directly and indirectly and seems to suffer more in a positive oil price shock. For Japan, Spain, Switzerland, and Turkey the results are reversed. They benefit from an oil shock directly and indirectly.

In this book we examined the impact of monetary policy on the crude oil market. Moreover, we have done surveys on the impacts of oil shocks on various economies incorporating monetary policies.