Demand and supply shocks in the oil market: Evidence from developed countries

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Conference Proceeding

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This paper researches the impact of demand and supply shocks in the crude oil market on industrial production indices in 18 industrialized economies. We examine different countries since an oil shock may have a differential impact on each of the countries due to different sectoral composition, their relative position as oil importer or exporter or their differential tax structure. In addition, there seems to have been a lack of non-US studies especially the ones that deal with the endogeniety issue of oil prices.

This paper deals with several issues. First, we treat oil prices as endogenous. Second, we determine the role of oil demand conditions and global macroeconomic conditions in defining the relationship between oil prices and industrial production. In particular, we examine the roles that oil supply shocks driven by political events, other oil supply shocks, demand shocks to industrial commodities, and precautionary demand shocks play in explaining industrial production. Third, we attempt to find if demand shocks in the crude oil market matter more than supply shocks. Fourth, the paper analyzes if net oil importers have a stronger response to oil shocks than net oil exporters.

Using a structural VAR model of the global crude oil market this paper looks at two different cases. In the first case, the global crude oil production measures the supply side effects. The demand side effects are measured by the Kilian index of global real economic activity (Kilian 2009) which is based on a global index of dry cargo single voyage freight rates. In the second case, a measure of oil supply shocks driven by political events is explicitly included as well. We find that impact of oil supply shocks is not as important as that of the demand shocks. We also find that the effect of a global demand shock, while positive and significant at first, eventually becomes negative. The precautionary demand shock seems to be more important than other shocks since it leads to significant responses for more horizons and more countries than the other shocks. We also find that there seem to be no clear connection between oil importer status and the response of a country to the shocks. Furthermore, inclusion of a political supply shock does not change our overall conclusion. Our findings show that further research efforts need to focus on developing theoretical models that address the underlying nature of an oil shock.

Publisher's Statement

© 2014 International Atlantic Economic Society. Publisher’s version of record: https://iaes.confex.com/iaes/78am/webprogram/Paper10930.html

Also presented at the 2015 Midwest Economics Association Annual Meeting, the 2015 Western Economic Association International Meeting, and the 2015 USAEE/IAEE North American conference.

Publication Title

78th International Atlantic Economic Conference