Transcript ppt

The impact of oil price shocks on the
UK: a time-varying SVAR
Stephen Millard and Tamarah Shakir
BOE, CAMA and MMF Workshop 25 May 2012
The impact of oil price
shocks on the UK
Outline
• Motivation and Literature
• Data
• The model and the estimation process
– Step 1: identifying oil shocks
– Step 2: impact on the UK
• Results
• Conclusions
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The impact of oil price
shocks on the UK
Motivation: Why care about oil shocks?
Sharp oil price rises appear to
be associated with world
recessions.
Real oil price and world recessions
US $/barrel
140
120
All but one of the US’ post-war
recessions has been preceded
by rise in oil price (Hamilton
(1983))
100
80
60
40
Concern that oil price shocks
may be ‘stagflationary’,
worsens the policy-maker’s
problem.
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20
0
1970
1980
1990
2000
2010
World GDP growth <3%
Oil price
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The impact of oil price
shocks on the UK
Motivation: Why care about oil shocks?
Real oil price changes
Percentage change on
a quarter earlier
60
40
• And oil prices are volatilesince the 1970s, real oil price
has repeatedly shown large
(and persistent) fluctuations.
20
0
-20
-40
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2009
2007
2004
2002
1999
1996
1994
1991
1989
1986
1984
1981
-60
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The impact of oil price
shocks on the UK
Literature: Headline impacts
• Most studies focus on the US.
• Different sample periods, different measures of oil prices
and changes but studies such as (Hamilton (1988 and
2000), Mork (1994), Bernanke, Gertler and Watson (1997)
all find substantial negative effects on GDP and positive
impacts on the level of prices.
• Some cross country studies- Jimenez-Rodriguez and
Sanchez( 2004) , Peersman and Robays ( 2009)- find smaller
effects for euro area than for the US.
• On-going debate about presence of asymmetric and nonlinear effects.
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The impact of oil price
shocks on the UK
Literature: How shock propagates
• Not the focus of our work. But still a lot of debate about
propagation of oil shocks, especially whether demand or
supply channels dominate.
• 3 mechanisms Hooker (2002)
– Wealth effect- through terms-of-trade
– Input price through production function
– Relative price shocks requiring rebalancing across sectors
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The impact of oil price
shocks on the UK
Literature: Impact over time
• Many studies also found evidence of decline in impact over
time- specifically a break somewhere around 1986.
(Hooker 2002)
• Possible explanations:
(1) the propagation of shocks has changed (the response)
– Oil intensity of the economy has fallen
– Policy responses have been better
(2) The shocks have been smaller (the impulse)
-look for asymmetric and non-linear responses
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The impact of oil price
shocks on the UK
Literature: Cause of the shock
(3) the cause of the shocks has changed
Often think of exogenous supply shocks generating large
spikes, but if cause are shocks to global demand, then
response of economy might be different.
Key papers in this area
• Kilian, L (2009), ‘Not all Oil Price shocks are alike’
• Baumeister C, Peersman G and I Van Robays (2009) , ‘ The
Economic Consequences of Oil Shocks: Differences across
Countries and Time’
• Peersman G and I Van Robays (2009), ‘Oil and the euro area
economy’
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The impact of oil price
shocks on the UK
Our question:
• Look at the impact on UK GDP, CPI and shortterm interest rates. In contrast to US focussed
studies.
• Identify three structural shocks to oil prices: oil
supply, global demand, and oil-specific demand
• Explicitly model time-variation for both oil market
and UK responses, using TVP-VAR as in Mumtaz
and various (2008, 2009, 2011)
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The impact of oil price
shocks on the UK
Our question: why time-varying?
• Captures impact of three possible changes
(1) Changes in the structure of the oil market
itself (how prices respond)
(2) General changes UK oil intensity and policy
framework
...and...
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The impact of oil price
shocks on the UK
Our question: why time-varying?
and, (3) for the UK , capture our transition from net oil
exporter to importer
UK crude oil trade balance (DECC)
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Thousand tonnes
2009
2006
140000
120000
100000
80000
60000
40000
20000
0
-20000
-40000
-60000
2003
2000
1997
1994
exports
1991
1988
1985
1982
imports
1979
1976
1973
1970
balance
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The impact of oil price
shocks on the UK
The model- 2 stage process overview
Had to keep the sets of variables manageable (≤4) to
be able to actually run the TVP-VARs. So we split the
process in two...
1. Oil VAR to model changes in oil price, identify three
structural shocks
2. UK VAR plus world variables
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The impact of oil price
shocks on the UK
Data
Quarterly series from 1965-Q2 2011
• Real, Sterling oil prices: UK Brent market price (IFS), RPI deflated
• World Oil production barrels per day: spliced series OPEC crude
production 1965-1973, EIA world crude production
• World GDP index: OECD data 1965-1980, in-house PPP weighted
series Datastream GDP data, IMF PPP weights (covers ≥75%
world)
• UK GDP and UK RPI: ONS
• UK short-term interest rates
• All differences in natural logs
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The impact of oil price
shocks on the UK
The model- Step 1
Start with a reduced form VAR for the world oil market
 Poil 


Yt   qoil 
 ywld 
p
Yt  ct   B j ,t Yt  j  v t
j 1
E vt v t   R t
E vt v s   0 if t  s
E v t   0
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The impact of oil price
shocks on the UK
The model- Step 1: introducing time-variation
Introduce time-variation
p
Yt  ct   B j ,t Yt  j  v t
j 1
β t  β t 1  e t
E et e t   Q
E et e s   0 if t  s
E e t   0
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The impact of oil price
shocks on the UK
The model- Step 1
p
Yt  ct   B j ,t Yt  j  v t
j 1
E vt v t   R t
β t  β t 1  e t
E et e t   Q
E et e s   0 if t  s
E e t   0
 1

A t  a21,t
 a31,t
0
1
a32,t
0

0
1
aij ,t  aij ,t 1  Vij ,t
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1
t
R t  A Ht A
h1,t

Ht   0
 0
0
h2,t
0

1
t
0

0
h3,t 
ln hi ,t   ln hi ,t 1   zi ,t
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The impact of oil price
shocks on the UK
The model- Step 1
p
Yt  ct   B j ,t Yt  j  v t
j 1
E vt v t   R t
β t  β t 1  e t
E et et   Q
E et e s   0 if t  s
E e t   0
 1

A t  a21,t
 a31,t
0
1
a32,t
0

0
1
aij ,t  aij ,t 1  Vij ,t
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 
E Vij2,t  Dij : EVt   0
1
t
R t  A Ht A
h1,t

Ht   0
 0
0
h2,t
0

1
t
0

0
h3,t 
ln hi ,t   ln hi ,t 1   zi ,t
 
E zi2,t  gi :Ezt   0
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The impact of oil price
shocks on the UK
The model- Step 1: Bayesian estimation
• Follow the notes from Applied Bayesian econometrics for
central Bankers: Haroon Mumtaz and Andrew Blake.
• Want to draw βt (coefficients in the oil relationships) and aij,t
(to then allow us to see the structural shocks ξt)
• Gibbs sampling approach – specifically the Carter-Kohn
algorithm for draws of βt and aij,t and the M-H algorithm for
stochastic volatility.
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The impact of oil price
shocks on the UK
The model- Step 1: Bayesian estimation
Need some priors for initial states of βt and aij,t
• Use OLS estimation of fixed coefficient VAR for the first 20
observations (i.e. 1965-1970)
And some priors for the hyper-parameters (Q, D and g)
• Q and D are assumed to be inverse Wishart: pQ ~ IW Q 0 , T0 
• Use a small scalar on T0 ( so low weight on prior values)
• g is inverse gamma
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The impact of oil price
shocks on the UK
The model- Step 1
-4
Stochastic Volatility World GDP
x 10
3
2.5
2
1.5
1
0.5
1975
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1980
1985
1990
1995
2000
2005
2010
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The impact of oil price
shocks on the UK
The model- Step 1
-3
x 10
Stochastic Volatility World Oil Production
1.8
1.6
1.4
1.2
1
0.8
0.6
0.4
0.2
1975
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1980
1985
1990
1995
2000
2005
2010
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The impact of oil price
shocks on the UK
The model- Step 1
Stochastic Volatility World Oil Price
0.25
0.2
0.15
0.1
0.05
1975
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1980
1985
1990
1995
2000
2005
2010
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The impact of oil price
shocks on the UK
The model- Step 1: Identifying shocks
• Want to impose sign restrictions on the coefficients of A0
• Follow Peersman and Roobays (2009)
Structural
shocks
Oil supply
World
demand
Oil specific
demand
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Oil
production ,
Qoil
<0
>0
>0
Oil price, Poil
World
demand, Ywld
>0
>0
≤0
>0
>0
≤0
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The impact of oil price
shocks on the UK
The model- the shocks
Oil production
World GDP
-4
-3
World prices
Stochastic Volatility World Oil Price
Stochastic Volatility World GDP
x 10
Stochastic Volatility World Oil Production
x 10
0.25
3
1.8
1.6
0.2
2.5
1.4
1.2
2
0.15
1
1.5
0.8
0.1
0.6
1
0.4
0.05
0.5
0.2
1975
1980
1985
1990
1995
2000
2005
2010
1975
Oil supply shock
1980
1985
1990
1995
2000
2005
World demand shock
Stochastic Volatility Oil supply shock
0.01
1985
1990
1995
2000
2005
2010
Stochastic Volatility Oil demand shock
x 10
Stochastic Volatility World demand shock
x 10
1980
Oil demand shock
0.002
16
10
0.2
1975
-5
-3
0.22
0.22
2010
9
14
0.18
8
12
0.16
7
0.14
10
6
0.12
8
5
0.1
4
0.08
6
3
0.06
4
2
0.04
0.001
2
0.002
1
0.02
0.02
1980
1985
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1990
1995
2000
2005
2010
1980
1985
1990
1995
2000
2005
2010
1980
1985
1990
1995
2000
2005
2010
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The impact of oil price
shocks on the UK
Oil price responses over time
Response of world oil price to an oil supply shock
0.15
0.1
0.05
0
20
15
2010
10
2000
1990
5
Impulse Horizon
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0
1980
Time
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The impact of oil price
shocks on the UK
Oil price responses over time
Response of world oil price to a world demand shock
0.15
0.1
0.05
0
20
15
2010
10
2000
1990
5
Impulse Horizon
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0
1980
Time
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The impact of oil price
shocks on the UK
Oil price responses over time
Response of world oil price to an oil demand shock
0
-0.02
-0.04
-0.06
-0.08
20
15
2010
10
2000
1990
5
Impulse Horizon
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0
1980
Time
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The impact of oil price
shocks on the UK
The model- Step 2
• The UK VAR plus world variables
Y2,t
 yuk 


  Puk 
iruk 
 y wld 


Y1,t   Po 
 O 
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p
p
i 1
i 1
Y2,t  cUK ,t   Bi , 21,t Y2,t i   B i , 22,t Y1,t i  v 2,t
E v2,t v 2,t   Rˆ 2t
E v2,t v 2,t   0 if t  s
E v 2,t   0
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The impact of oil price
shocks on the UK
The model- Step 2
• Repeat the estimation process from Step 1.
• Use first 20 observations to set priors etc.
• To identify responses of UK variables to given
structural oil shock, use a mapping from our
stage 1 VAR responses of the world variables
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The impact of oil price
shocks on the UK
The model- Step 2: mapping
Can re-write UK VAR as:
Bt ( L)Y2,t  c 2,t  Ct ( L)Y1,t  v 2,t
Leaving a structural moving average representation (for
responses of UK variables to unit shocks in world variables):
Y2,t  Bt (L) 1 Ct (L)
And can then multiply through by the earlier responses of the
world variables to identified structural shocks
Y2,t  B t (L) 1 Ct (L)A t (L)
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The impact of oil price
shocks on the UK
Results- Oil supply shock
Response of UK CPI inflation to an oil supply shock
Response of UK GDP growth to an oil supply shock
0.05
0.3
0
-0.05
0.2
-0.1
-0.15
0.1
-0.2
-0.25
0
20
20
15
2010
2000
10
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2010
10
1990
5
Impulse Horizon
15
0
5
1980
Time
2000
1990
Impulse Horizon
0
1980
Time
34
The impact of oil price
shocks on the UK
Results-World demand shock
Response of UK GDP growth to a world demand shock
Response of UK CPI inflation to a world demand shock
0.1
0
0.05
-0.05
0
-0.1
20
15
2010
10
2000
1990
5
Impulse Horizon
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0
20
15
2010
2000
10
1990
5
1980
Time
Impulse Horizon
0
1980
Time
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The impact of oil price
shocks on the UK
Results- Impact of oil price shocks on UK GDP
after 4 quarters
Impact on GDP after 4 quarters pp
2
1
0
-1
Oil demand
-2
World demand
-3
Oil supply
-4
-5
1977 1980 1983 1986 1989 1992 1995 1998 2001 2004 2007 2010
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The impact of oil price
shocks on the UK
Results- Impact of oil price shocks on UK RPI
after 4 quarters
Oil dem and
Im pact on CPI after 4 quarters pp
World demand
5.0
Oil supply
4.0
3.0
2.0
1.0
0.0
-1.0
-2.0
-3.0
1977 1981 1985 1989 1993 1997 2001 2005 2009
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The impact of oil price
shocks on the UK
Conclusions- source of the shock matters
• Oil supply shocks associated with larger negative impacts
on UK output and positive impacts on inflation
• Oil demand shocks associated with smaller, sometimes
positive, effects on UK output and inflation.
• Findings consistent with studies for other countries. But
given UK is small relative to rest of world, finding was not
clear a priori.
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The impact of oil price
shocks on the UK
Conclusions- time-variation in UK responses
• Impact of oil supply shocks on output and inflation
fell around the mid-1980s. And world oil market
SVAR suggests that changes in world oil market (incl.
vol of production) was important.
• Also observed that UK variables became more
sensitive to all types of oil shock after the mid-2000s.
Not noted in other studies, and may be unique to UK
transition from net exporter to importer.
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The impact of oil price
shocks on the UK
Questions
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