Energy Policy 129 (2019) 89–99

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Energy Policy
journal homepage: www.elsevier.com/locate/enpol

Review article

Oil price shocks and U.S. economic activity T

a,⁎ b c
Ana María Herrera , Mohamad B. Karaki , Sandeep Kumar Rangaraju
a
Department of Economics, Gatton College of Business and Economics, University of Kentucky, Lexington, KY, 40506-0034, USA
b
Department of Economics, Adnan Kassar School of Business Administration, Lebanese American University, 1515 Business Building, Beirut, Lebanon
c
Department of Economics, Goddard School of Business & Economics, Weber State University, 1337 Edvalson St., Dept 3807, Ogden, UT 84408, USA

A R T I C LE I N FO A B S T R A C T

JEL classification: Our understanding of the sources of oil price fluctuations and their effects on the U.S. economy has undergone
C32 important transformations in the last decades. First, several studies have demonstrated the importance of
E32 identifying the causes of oil price fluctuations, whether they are driven by demand or supply shocks, instead of
Q41 assuming that oil price changes are exogenous to the evolution of the world's economic activity. Second, new
Q43
methodologies have allowed researchers to re-evaluate the functional form of the relationship between oil prices
Keywords: and U.S. GDP, its components and job flows. Third, significant advances have been made in understanding the
Oil prices relationship between oil price uncertainty, news, economic policy uncertainty and aggregate economic activity.
Economic activity
Finally, investigations into the time-varying nature of oil price-macroeconomy relationship have provided im-
Transmission channels
portant insights into the reasons why unexpected increases in oil prices appear to shock less now than in the
Supply
Demand 1970s. This paper reviews the studies that have contributed to these different aspects of the literature.
Asymmetries

1. Introduction testing ground for new econometric methods. We start by reviewing the
theoretical underpinning for the supply and demand transmission
The oil crisis of the 1970s spurred the interest of academics, policy channels, paying particular attention to whether these channels imply
makers and practitioners in studying the relationship between oil price an asymmetric response of economic activity to positive and negative
fluctuations and economic activity. Our understanding of the source of oil price shocks.
these fluctuations, as well as their effects, has evolved considerably Most of this paper is concerned with empirical studies that explore
since then; recent advances in time series econometrics have enabled the relationship between oil price changes and the macroeconomy.
researchers to quantify the role of supply and demand driven oil price Earlier investigations, following the oil crises of the 1970s, presumed
increases and to investigate the functional form of the oil price-mac- that oil price fluctuations stemmed from disruptions in the Middle East
roeconomy relation, dynamic general equilibrium models that tackle and were exogenous to the U.S. economy. Hence, crude oil prices were
the role of volatility and different structural shocks have been devel- taken as given when testing whether oil price movements had pre-
oped, and textual analysis of news-media has bolstered a line of re- dictive content for future changes in real economic activity. Later stu-
search into the link between economic policy uncertainty and oil price dies that relied on vector autoregressions assumed that oil prices were
fluctuations. predetermined with respect to the macroeconomic variables of in-
The aim of this paper is to present a selective review of the literature terest.1 These studies found some empirical support for a recessionary
on the effects of oil price shocks on U.S. aggregate economic activity. impact of positive oil price shocks.
Instead of providing an extensive survey, we review the seminal papers As researchers extended the sample period to include the oil price
in the area and then focus on studies that have advanced our under- collapse of the mid-1980s, the empirical evidence for a link between oil
standing of the effects of oil price shocks by applying new methodol- prices and the macro economy further weakened. A line of investigation
ogies or using new datasets. Although there is a large and growing into the functional form and structural stability of the relationship thus
literature examining the effect of oil price shocks in an international emerged. Initially, this literature revealed a seemingly asymmetric ef-
setup, this paper focuses on U.S. data which have been the primary fect of oil price increases and decreases on future GDP growth.

⁎
Corresponding author.
E-mail addresses: [email protected] (A.M. Herrera), [email protected] (M.B. Karaki), [email protected] (S.K. Rangaraju).
1
Motivation and evidence for this assumption may be found in Kilian and Vega (2011).

https://doi.org/10.1016/j.enpol.2019.02.011
Received 9 August 2018; Received in revised form 1 February 2019; Accepted 2 February 2019
0301-4215/ © 2019 Elsevier Ltd. All rights reserved.
A.M. Herrera et al. Energy Policy 129 (2019) 89–99

However, improvements in econometric methodology in the last ten distribution of capital and labor. Hence, costly sectoral reallocation
years have called into question this conclusion. When reviewing the would amplify the effect of an unexpected energy price change beyond
literature on the effects of oil price shocks on aggregate economic ac- the share of energy expenditure in GDP.
tivity, labor reallocation, consumption and investment, we discuss the All in all, transmission channels that operate through the realloca-
contributions made by studies that use these newer econometric tech- tion of labor (or capital) amplify the supply-side effect of oil price
niques. shocks beyond the share of crude oil in the value added. Moreover, they
One of the big advances in our understanding of the sources of oil imply an asymmetric response of economic activity to unexpected oil
price shocks has been the recognition that, with an integrated global oil price increases and decreases.
market, oil price fluctuations are not only driven by supply disruptions
but also by changes in the demand for crude oil. Thus, recent empirical 2.2. Demand side channels
studies have aimed at identifying the source of oil price changes, as well
as estimating the impact of supply and demand driven shocks. An in- Oil price shocks may also affect aggregate economic activity
creasing body of literature aimed at modeling the effect of these through demand side channels. First, an unexpected increase in oil
structural shocks suggests identifying the source of the shock is key for prices is associated with higher energy and, especially, gasoline prices.
understanding the response of real oil prices and aggregate economic The more expensive gasoline is, the more households have to spend on
activity. This review summarizes these recent developments. transportation and, thus, the smaller their discretionary income. Hence,
A rapidly growing line of investigation has addressed the interaction unexpected increases in the price of crude oil lead to reductions in
between uncertainty, oil prices and economic activity. This literature purchasing power and discretionary income, which result in curtailed
has provided new insights into the effect of heightened oil price un- consumption expenditure (see, e.g. Edelstein and Kilian, 2009,
certainty on economic activity and investment decisions, as well as on Baumeister and Kilian, 2016; Baumeister et al., 2018). The magnitude
the impact of news on consumption. of this discretionary income effect will be larger the less elastic the
The remainder of this paper is organized as follows. Section 2 dis- demand for energy is, but its magnitude will be limited by the share of
cusses the theoretical foundations for the different transmission chan- energy spending on aggregate personal consumption expenditure. Be-
nels of oil price shocks. Section 3 reviews the literature that seeks to cause the nominal energy share has always been smaller than 10% –
disentangle the role of supply and demand driven oil price shocks. according to the Bureau of Economic Analysis it was 4% in 2017– , this
Section 4 presents the empirical evidence regarding the effect of oil effect is likely to be small.
price shocks on aggregate economic activity. More specifically, we re- Unexpected oil price increases may also operate through costly re-
view the literature that investigates the impact of oil price shocks on allocation of labor and capital across sectors (see Hamilton, 1988; Davis
output, consumption, and investment. Section 5 reviews the studies that and Haltiwanger, 2001). Following an unexpected increase in the real
investigate the effect of oil price shocks on stock returns. Section 6 price of oil, resources may relocate from industries that use energy
reviews work that analyzes the impact of oil price shocks on job flows. intensively in consumption (e.g., motor vehicles) or production (e.g.,
Section 7 summarizes the contributions of studies that focus on the chemicals), to industries that rely less on energy. Yet, this reallocation
interaction between uncertainty, oil prices and economic activity. process is costly due to the mismatch between the desired and actual
Section 8 discusses several papers that have investigated whether the distribution of capital and labor. Hence, costly sectoral reallocation
effect of oil price shocks has changed over time and Section 9 con- would amplify the effect of an unexpected energy price change beyond
cludes. the share of energy expenditure in GDP, leading to an increase in in-
voluntary unemployment. Hamilton (1988) work proposed another
2. The transmission channels of oil price shocks: Theoretical channel whereby costly labor reallocation may amplify the impact of oil
underpinnings price fluctuations on economic activity and may lead to an increase in
voluntary and involuntary unemployment. He argued that as oil prices
Unexpected exogenous increases in the price of oil can be trans- increase and workers get laid off, these workers will tend to wait until
mitted to real economic activity through a variety of channels. This conditions in the sector where they work improve rather than decide to
section reviews theoretical transmission mechanism and discusses relocate to other industries. Thus, the presence of frictions in the re-
whether the mechanism at hand implies a symmetric response to po- allocation of resources implies that higher oil prices may amplify re-
sitive and negative oil price shocks. cessions and mitigate expansions.
However, the effect of an oil price shock might be amplified via the
2.1. Supply side channels operating cost channel. Indeed, following an unanticipated increase in
the real price of oil, consumers could reduce their spending on durable
Most macroeconomics textbooks posit that exogenous oil price goods that are intensive in the use of energy (see, Hamilton, 1988 and
shocks affect real output and inflation because they constitute a nega- Kilian, 2014). Work by Edelstein and Kilian (2007), Edelstein and Kilian
tive supply shock for the domestic economy of an oil importing country. (2009) found that spending on automobiles is affected by this channel.
More specifically, an unexpected increase in oil prices is assumed to However, they found no evidence for the operating cost channel on
decrease the economy's aggregate supply as it increases the cost of other consumption spending components that use energy.
production (see Rotemberg and Woodford, 1996). In an economy where Hamilton (2009b), Blanchard and Galí (2010), Edelstein and Kilian
the aggregate production function is continuous and differentiable, the (2009) and Baumeister and Kilian (2016) posit that oil price shocks
effect of an increase in energy prices is bounded by the share of energy primarily affect the economy through variations in discretionary in-
expenditure in GDP. This direct supply channel implies a symmetric come that, in turn, lead to changes in consumer spending. Baumeister
response of real economic activity to positive and negative oil price et al. (2018) show that the discretionary income channel is identical to
shocks. the terms of trade channel. This transmission channel implies a sym-
Unexpected oil price increases may also operate through costly re- metric response of aggregate economic activity to oil price increases
allocation of labor and capital across sectors (see Hamilton, 1988; Davis and decreases.
and Haltiwanger, 2001). Following an unexpected increase in the real General equilibrium models such as those proposed by Rotemberg
price of oil, resources may relocate from industries that use energy and Woodford (1996), Finn (2000) and Leduc and Sill (2004) provide
intensively in consumption (e.g., motor vehicles) or production (e.g., other mechanisms whereby the contractionary effect of oil price in-
chemicals), to industries that rely less on energy. Yet, this reallocation creases might be amplified. In Rotemberg and Woodford (1996) the
process is costly due to the mismatch between the desired and actual amplification is generated by the interaction of mark-up pricing and

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A.M. Herrera et al. Energy Policy 129 (2019) 89–99

labor utilization, whereas in Finn (2000) and Leduc and Sill (2004) Lippi and Nobili (2012) built on the work by Backus and Crucini
amplification is due to capital utilization and, in the latter, due to the (2000) to develop a theoretical model with two industrialized countries
presence of wage rigidities. Yet, none of the mechanisms proposed in -the United States and the rest of the industrialized world (RoW)– and
these models trigger an asymmetric response of economic activity and an oil exporting country. This theoretical framework allowed them to
the empirical support for these mechanisms is unclear. trace the effect of aggregate demand and supply shocks –originating in
The real options literature (Bernanke, 1983; Pindyck, 1991) posits the US and the RoW- on the oil importing economies. They then
that an increase in uncertainty regarding the present value of future mapped the fundamental shocks derived from the model to the ob-
cash flows will lead to a decline in the purchase of capital goods. These served responses of real oil prices and oil production in a sign-identified
theories would thus suggest that if oil price increases are associated SVAR. Lippi and Nobili's (2012) estimates of the effect of an oil supply
with heightened uncertainty about future profits, investment will de- shock are similar to those of Kilian (2009b), albeit more negative and
cline. In addition, if heightened uncertainty about future oil prices persistent. In addition, they showed that unexpected increases in rest-
causes households to incur higher precautionary saving, a reduction in of-the-world demand –which are associated with increases in oil
households' spending on both durable and nondurable goods will ensue market-specific demand- lead to an increase in the real price of oil and a
(Edelstein and Kilian, 2009). In brief, unexpected increases in oil prices decline in U.S. industrial production, whereas demand shocks that
that result in greater uncertainty about future oil prices may cause originate in the U.S. had the opposite effect.
households and firms to postpone spending on durable goods and in- Kilian and Murphy (2014) later refined their own methodology (i.e.,
vestment and thus may lead to a decline in aggregate output. Kilian and Murphy, 2012) to account for the role of speculation in
A related channel through which increased oil price uncertainty driving oil price fluctuations. They included the change in global in-
may have a negative effect on real GDP is related to the presence of ventories in their sign-identified SVAR and modified the identification
nominal rigidities. Plante and Traum (2014) show that in a New Key- assumptions accordingly. Similar to the previous studies, Kilian and
nesian model where oil usage affects the utilization rate of capital, the Murphy (2014) found that oil supply disruptions explain a small pro-
interaction of precautionary saving motives and nominal rigidities re- portion of the movements in real oil prices relative to flow demand and
sults in a slowdown in real GDP when the economy is hit by an exo- speculative demand shocks.
genous increase in real oil price volatility. Similarly, Başkaya et al. Recent work by Baumeister and Hamilton (2019) proposes a fra-
(2013) find that increases in oil price volatility that operate in con- mework where the researcher's beliefs on information about the con-
junction with higher oil prices lead to economic contractions. In brief, temporaneous coefficients are summarized through priors on particular
recent theoretical studies that tackle the effect of heightened un- parameters. Baumeister and Hamilton (2019) findings stand in contrast
certainty in a general equilibrium framework uncover a transmission to the earlier literature (e.g., Kilian, 2009b; Kilian and Murphy, 2012
channel that could amplify the effect of oil price shocks, and may lead and Kilian and Murphy, 2014) in that they estimate a larger contribu-
to asymmetries in the response to oil price increases and decreases. tion of oil supply shocks to historical movements in oil prices. This
estimated larger role of oil supply shocks may be traced back to the
3. Accounting for fluctuations in oil prices: supply, demand and assumptions inherent in their model.2
speculation Herrera and Rangaraju (2018) investigated how different identifi-
cation assumptions and modeling strategies influence estimates of the
Since the 1970s energy crisis, academics and policy makers have effects of oil supply shocks on real oil prices and U.S. real GDP. They re-
been interested in understanding what causes unexpected movements evaluated the time-invariant SVAR models of Kilian (2009b), Kilian and
in oil prices and the consequences of these changes. Until the early Murphy (2012), Kilian and Murphy (2014), Baumeister and Hamilton
2000s it was common to study the effect oil price shocks on aggregate (2019) using a common sample that spans the period between January
economic activity without differentiating the source of the shock. This 1973 and December 2016. First, they confirmed the importance of in-
practice was motivated by the belief that large changes in the price of cluding crude oil inventories in the SVAR to correctly pin down the
crude oil had been historically driven by supply disruptions in the price elasticity of oil demand (see Kilian and Murphy, 2014). Second,
Middle East, which were exogenous to U.S. macroeconomic outcomes. they showed that models that impose a small short-run price elasticity
Yet, in the last fifteen years or so, it became evident that this empirical of supply (Kilian and Murphy, 2014) result in a smaller response of the
strategy was incorrect. real oil price to oil supply disruptions than specifications that allow for
Barsky and Kilian (2002) were the first to note that assuming exo- a larger elasticity (Baumeister and Hamilton, 2019). They showed that,
geneity was problematic as crude oil prices could respond to demand if the researcher is willing to consider a prior that conditions on values
shifts reflected in higher global real economic activity, thus violating of the short-run price elasticity of oil supply that are supported by
the exogeneity assumption. Motivated by this idea, as well as by re- microeconomic estimates, the differences in the response of real oil
cognizing that oil price movements are a result of both supply and prices to oil supply shocks across specifications diminish.
demand forces, Kilian (2009b) developed a structural vector auto- The work by Aastveit (2014) contributes to this literature by using a
regressive model (SVAR) of the global oil market that decomposed the richer data set in a factor augmented vector autoregressive (FAVAR)
dynamics of oil prices into the components associated with changes in model. He examined the impact of different types of oil shocks on a
supply and demand. To identify the shocks, Kilian (2009b) imposed a wide range of U.S. macroeconomic variables. He confirmed that oil
recursive structure in the SVAR –which implied a short-run vertical demand and oil supply shocks have different effects on the responses of
crude oil supply– and estimated the model using monthly data from the real price of the oil, real economic activity, the labor market, and
January 1973 to October 2006. He showed that oil supply shocks ac- the stock market. Aastveit (2014) findings coincide with previous stu-
counted only for a small part of the variation in real oil prices whereas a dies: oil demand shocks are far more important than oil supply shocks
large part of the fluctuations had been driven by demand shocks. as much of the variation in oil prices and other macroeconomic vari-
The framework developed by Kilian (2009b) was extended and ables arises from shifts in the aggregate demand or oil specific demand.
modified in the following years. For instance, Kilian and Murphy (2012) As we mentioned earlier, this paper focuses on U.S. economic ac-
investigated the sensitivity of Kilian (2009b) findings to alternative tivity. However, an increasing number of papers has looked into the
identification schemes. More specifically, instead of imposing exclusion contribution of demand and supply driven shocks to economic activity
restrictions, they attained identification by using sign restrictions. The in an international setup (see Bodenstein et al., 2012). An example is
findings of Kilian and Murphy (2012) resembled those of Kilian (2009b)
in that oil supply disruptions explained only a small fraction of the
2
variation in the real price of crude oil. See Kilian and Zhou (2018) for a detailed discussion.

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A.M. Herrera et al. Energy Policy 129 (2019) 89–99

the work by Lippi and Nobili (2012) discussed above. inconsistent and exaggerate the recessionary effects of higher oil prices.
In brief, our summary of the methods and findings concerning the Instead, they proposed a nonlinear model that nests both symmetric
role of supply and demand shocks in driving oil prices and economic and asymmetric responses of aggregate economic activity to oil price
activity reveals two key insights. First, the inclusion of changes in crude increases and decreases. They found that real GDP growth responds
oil inventories in the SVAR model is key to identify the role of spec- symmetrically to positive and negative oil price shocks. In contrast with
ulation as well as to correctly estimate the short-run price elasticity of the earlier literature, Kilian and Vigfusson (2011a), Kilian and
oil demand. Second, while differences in the estimated response of the Vigfusson (2011b), Kilian and Vigfusson (2017) showed that a linear
real oil price to supply and demand driven shocks are largely driven by model provided a good approximation for the oil price-real GDP re-
the identification assumptions, the consensus that has emerged from lationship.5 Evidence of asymmetric responses to oil price shocks exists,
this studies is that demand shock account for a large proportion of the if at all, only when large (2 standard deviations) shocks are considered
fluctuation in oil prices. and tends to be sensitive to the inclusion of the Great Recession period.
Only in some disaggregate data is there credible evidence of asym-
4. Oil price shocks and U.S. economic activity metric responses.6
Regarding the interaction between oil price shocks and monetary
In this section, we review the empirical studies that analyze the policy, some disagreement remained by the mid-2000s. In particular,
effect of oil prices shocks on U.S. economic activity. To get a better view while some economists have considered oil price shocks as the cause
on the empirical relevance of the various transmission mechanisms, we behind economic downturns, others have argued that the recessionary
also discuss papers that investigate the impact of oil prices on aggregate impacts associated with higher oil prices were mostly a result of the
output, consumption, investment and stock returns. contractionary monetary policy implemented by the Fed to prevent any
inflationary pressure on the economy (see Bohi, 1989). Bernanke et al.
(1997) – hereafter BGW – provided some evidence supporting this view.
4.1. The impact on aggregate output Using a censored structural vector autoregression model,7 they con-
ducted a counterfactual analysis where the systematic monetary policy
Following the 1970s stagflation, economists became interested in response was shut down such as to keep the federal funds rate at its pre-
analyzing the effect of fluctuations in oil prices on economic activity. oil shock level. Their counterfactual analysis implied that, had the
Indeed, over the years, a large number of empirical studies found a federal funds rate remained unchanged following an unexpected in-
statistically significant relationship between higher oil prices and lower crease in the real price of oil, then the recession could have been
economic activity.3 The earliest contributions to this literature con- avoided. Hamilton and Herrera (2004) challenged this conclusion on
sidered linear regression models and tested whether oil price changes two basis. First, they showed that the BGW's counterfactual was not
Granger caused aggregate economic activity (see e.g., Hamilton, 1983). feasible as it entailed a large and persistent increase in the price level;
Since then, this body of literature has vastly expanded. Thus, instead hence, the required monetary policy shocks would not have been
of reviewing all the papers, we focus on two areas of research that have modest. Second, Hamilton and Herrera (2004) found that BGW results
captured the interest of academics and policy makers: the functional were largely driven by the use of shorter lag structure, which was in-
form of the relationship between oil price changes and aggregate pro- consistent with the more delayed response of economic activity found
duction and the interaction between monetary policy and oil price by previous studies.
shocks. Along similar lines, Herrera and Pesavento (2009) investigated
After the 1986 oil price collapse, studies that explored the oil price- whether the contribution of systematic monetary policy to the eco-
macroeconomy relationship using longer samples found evidence of nomic recession that ensued an oil price shock was different before and
instability in the relationship. This instability was then shown to be during the Great Moderation. They showed that the contribution of
connected to an asymmetric response of U.S. economic activity to oil systematic monetary policy to the dynamic response of output and
price increases and decreases. Mork (1989) showed that if a researcher prices was considerably smaller during the Volcker-Greenspan era than
regressed the real GNP growth on lags of oil price increases and de- before the Great Moderation. Moreover, if the response of systematic
creases (controlling for other non-oil variables), the lags on the de- monetary policy had been shut-down for a year, the volatility of GDP
creases were statistically insignificant whereas the lags on the increases growth would have declined 27% in the pre-1980 period but only 8% in
were jointly significant and negative. Similarly, Hooker (1996) im- the post-1980 period.
plemented rolling Granger causality and structural stability tests and Kilian and Lewis (2011) – hereafter KL – also built on the work of
found that the oil price-macroeconomic relation seemed to have be- Hamilton and Herrera (2004) by using additional data and methodo-
come unstable. Motivated by these findings, Hamilton (1996), logical advances to show that the response of monetary policy to oil
Hamilton (2003) proposed an asymmetric functional form based on a price shocks did not lead to important output fluctuations even in the
nonlinear transformation of the real price of oil (the net oil price in- pre-Volcker period. They observed that the censored VAR model
crease) that corrects for previous oil price declines. Nonlinear models
that analyze the dynamic relationship between oil prices and the
macroeconomy thus became the workhorse of the empirical literature 5
Hamilton (2011) disagrees with Kilian and Vigfusson (2011a) and claims
for the next twenty years.4
that the lack of evidence against the null of symmetry based on the slope-based
By the early 2000s, researchers seemed to agree that unexpected
test, which Kilian and Vigfusson (2011a) insist should not be used, is due to
increases in oil prices were correlated with economic contractions different datasets, different measures of oil prices, different price adjustment,
whereas oil price declines had no significant effect on the economy. the inclusion of contemporaneous regressors and the number of lags. Kilian and
Kilian and Vigfusson (2011a) questioned the methodology used by Vigfusson (2011b) refute these arguments. The substance of Kilian and Vig-
previous studies to examine the issue of asymmetry. They observed that fusson's findings is also supported by more recent research including Kilian and
these studies were based on censored VAR models and proved that the Vigfusson (2013), Kilian and Vigfusson (2017) and Ravazzolo and Rothman
impulse response estimates reported in the earlier literature are (2013).
6
See Herrera et al. (2011), Herrera et al. (2015), Alsalman and Herrera
(2015), Herrera and Karaki (2015), Kilian and Vigfusson (2011b) and Karaki
3
See, e.g., Rasche and Tatom (1977), Rasche and Tatom (1981), Hamilton (2017).
7
(1983) and Burbidge and Harrison (1984). It is important to note that Kilian and Vigfusson (2011a) proves that impulse
4
See, e.g., Loungani (1986), Mork (1989), Lee et al. (1995), Davis et al. responses estimated using VAR models with censored oil price variables are
(1996), Lee and Ni (1996), Balke et al. (2002). inconsistent and invalid.

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A.M. Herrera et al. Energy Policy 129 (2019) 89–99

estimated in BGW was subject to the pitfalls expounded in Kilian and discretionary income are at play. In particular, EK suggest that the fact
Vigfusson (2011a) and thus estimated a linear SVAR. Despite the dif- that spending on motor vehicles is more responsive than spending on
ferences in data frequency, model specification and sample period, KL other durables indicates that the operating cost channel is relevant.
findings are similar to Herrera and Pesavento (2009). Their analysis EK sought to disentangle the importance of different transmission
suggests that the systematic response of monetary policy to oil price channels for consumption. In contrast, Alsalman and Karaki (2019)
shocks was more concerned with stabilizing output before the mid-80s –hereafter AK– investigated whether personal consumption expenditure
and was less responsive to oil price shocks since the start of the Great responds asymmetrically to positive and negative structural shocks in
Moderation. the crude oil market. Moreover, they studied whether the effect of oil
While the literature includes a large number of papers that in- price changes on personal consumption expenditure depends on the
vestigate the question of nonlinearity using data from OECD (see source of the shock. They found that aggregate PCE responds asym-
Herrera et al., 2015) and countries in the Gulf Cooperation Council (see, metrically to positive and negative oil-specific demand shocks. Their
e.g., Ben Cheikh et al., 2018), there are only a few papers exploring the results indicate that oil supply shocks have a limited effect on aggregate
connection between monetary policy and oil price shocks using non- PCE. However, a positive aggregate demand shock leads to a significant
U.S. data. Notable exceptions are Choi et al. (2018). This is clearly an reduction in aggregate PCE with a delay of about a year. This delay is
area where there is plenty of room for future research. explained by the combination of two dynamic responses. First, a posi-
We conclude this section by noting that there are several theoretical tive aggregate demand shock stimulates U.S. economic activity through
papers that explore the interaction between oil price shocks and sys- increased exports. Second, over time, as global economic activity rises,
tematic monetary policy (see e.g., Leduc and Sill, 2004; Kormilitsina, the real price of oil increases and output growth declines. Their results
2011; Plante, 2014). Because we restrict ourselves to reviewing em- suggest that oil-specific demand shocks significantly decrease aggregate
pirical studies we will abstain from including an extensive review of PCE for almost all horizons.
those papers. However, let us remark that Leduc and Sill (2004) address Regarding the components of PCE, Alsalman and Karaki (2019)
the same question as the above summarized empirical studies. Namely, found important differences in the responses to supply and demand
what is the contribution of the systematic monetary policy response to driven oil price shocks. First, they showed that an adverse oil supply
the recessionary effect of an oil-price shock? Their work, which uses a shock increases consumption spending on services, but decreases con-
calibrated general equilibrium model, supports the findings of the sumption spending on goods with the reduction in durables being larger
empirical literature in the sense that none of the monetary policies than in nondurables. Second, whereas they find a negative response of
commonly proposed are able to completely eliminate the recessionary PCE to aggregate demand shocks, there appears to be significant het-
impact of an oil price shock. erogeneity in the response across PCE components. For instance, while
This literature, however, has largely ignored the fact that the real most spending components exhibit a decline, other spending compo-
price of oil need not be exogenous with respect to the domestic nents –such as recreation services and nondurables– respond positively.
economy. The only theoretical analysis of monetary policy responses Last but not least, oil-specific demand shocks trigger an unambiguously
when the price of oil is endogenously determined in global markets is negative effect on most spending components. Indeed, a positive oil-
Bodenstein, Guerrieri and Kilian (2012) who show that it is detrimental specific demand shock largely reduces spending on motor vehicles and
to domestic welfare for the central bank to respond do oil price shocks new autos and increases spending on foreign autos.
directly. Most of the literature on the effect of oil price shocks on con-
sumption has focused on U.S. data. To the best of our knowledge, there
4.2. Do oil price shocks depress consumption? are only a few working papers that employ international data such as
Iacoviello (2016) and Bokan et al. (2018). This is clearly an important
In the literature that emerged after the 1970s oil price shocks, the area for future research as studying the effect of oil price shocks on
answer given to this question is positive, especially because oil price consumption for oil importing and oil exporting countries would im-
increases depressed the demand for motor vehicles. In fact, given that prove our understanding on the transmission mechanism of oil price
personal consumption expenditures constitute the largest component of fluctuations.
real GDP, it is probably not surprising that researchers still seek to In brief, recent investigations have confirmed the negative effect of
understand how oil price changes affect consumption. For instance, oil price shocks on U.S. aggregate consumption. However, the magni-
Edelstein and Kilian (2009) studied the impact of changes in purchasing tude of the effect appears to be modest (see Baumeister and Kilian,
power driven by fluctuations in oil prices on personal consumption 2016; Baumeister et al., 2018). These studies have underlined the im-
expenditure. They analyzed the effect on aggregate and disaggregate portance of the purchasing power and operating cost channels in ac-
spending components to assess the importance of the uncertainty and counting for the decline in aggregate consumption. Motor vehicles
the operating cost channels. They showed that the elasticity of personal continue to play a key role in explaining the contraction in PCE. This is
consumption expenditure with respect to the overall price of energy especially the case when the increase in oil prices is due to an un-
was negative for both aggregate and disaggregate spending compo- expected increase in oil-specific demand.
nents. Their findings indicated that spending on durables had the lar-
gest elasticity. They reasoned that the large response in durables con- 4.3. The effect of oil price shocks on investment
sumption stems from the reduction in spending on motor vehicles
following the negative shock to purchasing power caused by higher oil As noted earlier, there are several theoretical models that would
prices. This result falls is in line with the long held view that the au- imply a negative effect of oil price shocks on investment. Moreover,
tomobile sector suffered the most during periods of large oil price in- some of these models would predict an asymmetric response to oil price
creases (see for e.g. Davis and Haltiwanger, 2001; Ramey and Vine, increases and decreases. Empirical studies into the dynamic effects of
2006). oil price shocks on investment have lately focused on the question of
Edelstein and Kilian (2009) –hereafter EK– posit that if oil prices asymmetry, as well as on the impact of oil price uncertainty.
affect consumption only through the discretionary income effect, then For example, Edelstein and Kilian (2007) used a bivariate recur-
the response of consumption to an energy price shock should have an sively identified VAR model, with oil prices ordered first, to estimate
upper bound that is equal to the amount of the loss in purchasing the effect of oil price shocks on investment and to investigate the pre-
power. Nevertheless, they found that the response of consumption is sence of asymmetry. Their estimates provide some evidence of asym-
almost four times as large as the response of discretionary income, metry in the response of investment to oil price increases and decreases.
which they interpret as evidence that channels other than the Yet, Edelstein and Kilian (2007) argue that this asymmetry is an artifact

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for two reasons. First, they show that asymmetry in aggregate invest- depending on the underlying source of the shock. On the one hand,
ment is due to the inclusion of investment spending in the coal mining, changes in precautionary demand, especially those linked to political
and the oil and gas industries. In other words, investment in these in- disturbances in the Middle East, are shown to account for large de-
dustries falls when oil prices decline whereas lower oil prices foster creases in U.S. stock returns. On the other hand, oil price hikes that
investment in other industries. Second, Edelstein and Kilian (2007) stem from unanticipated increases in global economic activity have a
provide evidence that the apparent asymmetry is also due to the exo- positive effect on stock returns. Moreover, their study suggests that
genous shift in investment stemming from the 1986 Tax reform Act. In shocks to crude oil production have little impact on U.S. stock prices
other words, if the researcher accounts for these two factors, then the relative to oil price increases driven by changes in global economic
effect of oil prices on investment is small. activity or precautionary demand for crude oil. At the disaggregate
Baumeister and Kilian (2016) studied the effect of lower oil prices level, they found that alternative structural shocks to the crude oil
on investment during the recent oil price decline. They found that lower market have different effects on industry stock returns. For instance, an
oil prices led to a sharp decrease in investment in the oil sector. Fur- increase in the price of oil caused by a positive oil-specific demand
thermore, their findings revealed a limited increase in investment in shock generates a small increase in stock returns for the oil and gas
other sectors. They show that nonresidential investment grew at a industry whereas returns on shares of stocks for the auto industry will
slower pace than real GDP between 2014Q2 and 2016Q1 because of to experience a persistent decline. Their results reveal, however, that stock
the 48% decrease in oil investment. returns appreciate within a year for both industries when the oil price
Lee et al. (2011) studied the effect of oil price shocks on investment, increase is caused by a positive aggregate demand shock. Thus, Kilian
both by estimating the direct effect of oil price shocks on firm-level and Park (2009) findings emphasize that investors need to understand
investment and in interaction with firm stock price volatility and with the source behind the oil price adjustment in order to adequately adjust
firm sales growth. They use a panel of firm-level data for manufacturing their portfolios and suggest that one explanation for the early con-
firms (SIC code 2000–3999) spanning the period between 1962 and flicting results is a change in the composition of oil price shocks.
2006. They found that oil price shocks negatively affect investment. Alsalman and Herrera (2015) investigated an alternative explana-
They also show that firms that experience a higher degree of un- tion, the possible nonlinear nature of the relationship between oil price
certainty experience a sharper decline in investment spending following shocks and stock returns. Their study tests the null of symmetry in the
a reduction in the real price of oil. Finally, their results reveal that oil response of U.S. stock returns to positive and negative oil price in-
price shocks affect investment for at least two years after the shock. novations. They found evidence that a linear model does a good job at
In contrast, Kilian (2014) and Baumeister and Kilian (2016) find capturing the dynamic effect of oil price shocks for aggregate stock
little support for the hypothesis that increased uncertainty regarding returns. Yet, the response of stock returns for a few more disaggregate
future oil prices has a significant effect on investment on industries not portfolios (e.g., healthcare, textiles, aircraft) appears to be asymmetric.
related to the oil sector. Nor do they find a significant effect at the Baumeister and Kilian (2016) studied the effect of the sharp decline
aggregate level. These results suggest the lack of a consensus regarding in oil prices after June 2014 on stock returns. Their findings reveal that
the importance of the uncertainty channel at the aggregate level. lower oil prices during that period have appreciated stock returns for
Given the predominant role of the public sector on the exploration companies that produce consumer goods such as tobacco and food
and extraction of crude oil in most oil exporting countries, it is possibly products. Moreover, stock returns for retail sales companies appreciated
not surprising that the micro-level literature has focused on the U.S. more than stocks for the average company. For instance, they found
After all, investment and production by private firms is more prevalent that Amazon's stock returns have increased by 38%. Obviously, the
in the U.S. and the number of oil fields with good quality data is larger. biggest losers are companies in the petroleum and natural gas sector,
However, aggregate investment data is available at the country level where average stock returns declined by 28%.
from the National Income and Product Accounts (NIPA) and could thus Ready (2017) proposes a different method for separating demand
be exploited by future research to investigate the effect of oil price and supply driven changes in oil prices based on information on asset
shocks in other countries.8 prices. He first develops a simple model of oil production at the firm
Summarizing, there appears to be an agreement regarding the ne- level, which takes into account the fact that oil is a depletable resource,
gative effect of oil price shocks on investment. Furthermore, the theo- to motivate the classification of oil price shocks. He then estimates
retical implication of the real options theory –whereby investment trivariate SVAR model in the change in oil price, an index for oil pro-
would decrease in the face of heightened uncertainty– is borne out in ducing firms and innovations to the VIX, which allows him to extract oil
the data for oil drilling in Texas. demand and supply shocks. Identification is attained via short-run re-
strictions. The structural shocks are then projected into the market re-
turn, the aggregate CRSP stock index and a world-wide stock index
5. Oil price shocks and stock returns
from Global Financial Data. Unlike previous studies, Ready (2017) finds
that both supply shocks and demand shocks have a significant effect on
Empirical studies on the effect of oil price shocks on stock returns
U.S. and world stock prices. Moreover, industries that produce con-
have produced somewhat conflicting results over the years. On the one
sumer goods are more affected by supply driven shocks, whereas in-
hand, the earlier work of Chen et al. (1986) and Huang et al. (1996)
dustries that are intensive in the use of oil as an input are more affected
failed to find a significant relationship between prices of oil futures and
by demand driven shocks. Of course, unlike earlier studies, Ready's
stock returns. On the same vein, the more recent study of Wei (2003)
model is not designed to recover shocks to the global demand and
found that the oil price shock of 1973–74 had no significant effect on
supply of crude oil.
U.S. stock returns. On the other hand, Kling (1985) and Jones and Kaul
All in all, in the last decade or so, empirical investigations into the
(1996) provided evidence of a negative relationship between oil price
dynamic response of U.S. stock returns to oil price shocks have found
shocks and stock returns.
evidence of a statistically significant relationship. First, unexpected
Kilian and Park (2009) provided an explanation for these con-
increases in oil prices that stem from economic expansions or precau-
trasting results. Using the framework of Kilian (2009b) to model the
tionary demand for crude oil appear to have a greater negative impact
global oil market and identify the source of the oil price shock, they
on stock returns than oil price increases that stem from curtailed oil
demonstrate that the response of U.S. stock returns differs greatly
production. However, recent investigations suggest the effect of supply
driven shocks is stronger for stock returns of consumption goods
8
It is important to note that using international data creates a new challenge whereas that of demand driven shocks is stronger for sectors that use oil
because one has to model the real exchange rate (see Kilian and Zhou, 2018). intensively as an input. Second, whereas a linear model is a good

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approximation to the relationship between oil prices and aggregate U.S. manufacturing sectors when data mining robust critical values are used.
stock returns, a nonlinear model appears to be needed for some dis- Finally, HK investigated whether the effect of oil price shocks on job
aggregate portfolios. Finally, it is worth noting that empirical in- flows had changed since the start of the Great Moderation. Their results
vestigations using data for other oil importing countries have found that indicate that oil prices have led to larger changes in the response of job
oil price shocks have a negative or insignificant effect on stock returns reallocation since the mid-1980s, which can possibly be attributed to a
(see e.g., Park and Ratti, 2008; Cong et al., 2008, and Wang et al., change in the transmission mechanism through which oil prices op-
2013). In contrast, for oil exporting countries such as Norway (Park and erate.
Ratti, 2008) the impact is positive. Karaki (2018b) built on the work by Herrera and Karaki (2015) to
investigate whether regional job flows respond asymmetrically to oil
6. The effect of oil prices on job flows price increases and decreases. In line with Herrera and Karaki (2015),
he found no evidence against the null of symmetry after using data
As mentioned before, costly sectoral reallocation constitutes one of mining robust critical values. His investigation contributed to the lit-
the transmission channels that amplify and generate asymmetries in the erature on regional U.S. business by showing that oil price shocks
response of economic activity to oil price shocks. In this subsection, we trigger limited job reallocation across U.S. states.
review the literature that evaluates the empirical relevance of this While DH and HK focused on the effect of oil prices on job flows in
transmission channel. In particular, we focus on the process of labor the manufacturing sector, Herrera et al. (2017) – hereafter HKR –
reallocation among firms. analyzed the effect of oil price shocks on job flows on various sectors of
Davis and Haltiwanger (2001) – hereafter DH – studied the effect of the U.S. economy (i.e., agriculture, construction, mining, utilities,
oil price shocks on aggregate and sectoral job creation and job de- manufacturing and services). They found the effect of oil price shocks
struction using a structural near-VAR model. Their empirical frame- on job creation and destruction for industries in the agriculture and
work takes into account the possible asymmetry in the response of labor utilities sectors to be limited. Nevertheless, they showed that an un-
flows to oil price shocks by including the absolute change in their oil expected decline in oil prices reduces the pace of job creation for the oil
price index as a measure of oil prices in the near-VAR. Their findings and gas industry and decreases net employment in support activities for
indicate that oil price shocks have a stronger effect on job flows in mining. Moreover, they found that an unexpected decline in the real
manufacturing than monetary policy shocks. Moreover, their results price of oil leads to a decrease in the excess job reallocation rate, which
show that job destruction is more responsive than job creation to oil indicates a reduction in the fluidity of labor markets within these in-
price innovations. DH concluded that unexpected increases in the real dustries. As for the services sector, the sector that has the largest share
price of oil have an asymmetric effect on the response of job creation of employment in the U.S. private sector, HKR found that lower oil
and destruction in total manufacturing. These asymmetries can be di- prices generate a significant reduction in the excess job reallocation rate
rectly related to the transmission mechanism through which oil prices for almost all industries. Their results indicate that following a decline
operate. DH argued that if oil price shocks operate through aggregate in the real price of oil, jobs shift away from the oil and gas industry to
channels, then an unexpected increase in the real price of oil will lead to industries in manufacturing, services and construction. As theory would
a decrease in job creation and an increase in job destruction. However, suggest, the job creation rate tends to increase the most for industries
they argued that if oil shocks primarily operate through the costly that are energy intensive.
sectoral reallocation channel, then a positive oil price shock will lead to HKR make a novel contribution to the literature by evaluating
an increase in both job creation and job destruction implying a positive whether the response of job creation and destruction is driven by
change in the gross job reallocation rate. Based on a visual examination changes in job flows from entering and closing firms or existing firms.
of the impulse response functions, DH concluded that important Their results demonstrate that a year after the reduction in the real oil
asymmetries were evident in the responses of industry-level job crea- price, the increase in total private job creation is mainly explained by
tion and job destruction to a positive oil price shock. The magnitude of increases in job creation from expanding establishments in services and
these asymmetries was larger for industries that have a higher degree of manufacturing. However, by the second year, the continued increase in
energy intensity, capital intensity, and product durability. For instance, job creation can be attributed to increases in job creation for both
DH found important asymmetries in the response of job creation and opening and expanding establishments in services, manufacturing and
job destruction to a positive oil price shock in the transportation construction. As for the response of total private job destruction, HKR
equipment industry. Their results imply that oil price shocks give way found that the increase in job destruction, a year after the shock, is
to important costly reallocation effects, which amplify the recessionary accounted for by the pace of job destruction in closing establishments.
impact of oil price increases and diminish the expansionary impact of Yet, at longer horizons, changes in job destruction for contracting es-
lower oil prices. tablishments explain a larger part of the changes in total private job
Kilian and Vigfusson (2011a), Kilian and Vigfusson (2011b), Kilian destruction.
and Vigfusson (2017) criticized studies that incorrectly incorporated In brief, recent empirical evidence suggest that changes in job flows
censored variables as both regressands and regressors in censored oil play an important role in the transmission of oil price shocks to U.S.
price VAR models because they yield inconsistent estimates of the re- economic activity. In particular, unexpected oil price increases lead to
sponse to oil price shocks. In fact, they showed that these censored significant declines in net employment growth for industries that use
VARs produced biased estimates of the impulse response functions. energy intensively but foster employment in the oil and gas industry.
Using the methodology proposed by KV (2011a), Herrera and Karaki However, statistical evidence of an asymmetric response to oil price
(2015) – hereafter HK – reevaluated the empirical evidence on the ef- increases and decreases in aggregate job creation and job destruction is
fect of oil price shocks on job creation and job destruction. They first tenuous and is only found for a few energy-intensive sectors.
investigated whether job flows respond asymmetrically to positive and
negative oil price innovations and found little evidence against the null 7. Oil price uncertainty, information and aggregate economic
of symmetry, especially after accounting for data mining. Then, they activity
tested whether an unexpected increase in the real price of oil leads to a
significant change in the job reallocation rate. A glance at their impulse Several theoretical models imply a negative effect of increased oil
response estimates suggests that oil price shocks have a significant ef- price volatility on real economic activity, consumption and investment.
fect on gross reallocation rates for several industries such as textiles, Hence, a strand of literature has aimed at empirically analyzing dif-
petroleum and coal, rubber and plastics and transportation equipment. ferent aspects of uncertainty associated with oil price shocks. A related
However, they fail to reject the null of symmetry for job flows in most and complementary line of investigation has explored the impact of

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unexpected changes in oil prices on economic uncertainty as well as the Van Robays (2016) used a threshold VAR model that allows for
effect of news regarding oil price changes. In this section we review the nonlinearities in the response function, to assess whether macro-
work related to these topics. economic uncertainty affects oil price volatility. The high/low un-
certainty regimes are defined as periods in which world industrial
production growth is higher/lower than a threshold value, which is
7.1. Oil price uncertainty
estimated within the model. Conditional on being in a low or high
uncertainty regime, Van Robays (2016) estimated the impact of oil
Lee et al. (1995) and Ferderer (1996) were possibly the first studies
supply and demand shocks on the real price of the oil. The estimation
to explore the importance of oil price uncertainty in driving economic
results indicated that higher macroeconomic uncertainty leads to
activity. Lee et al. (1995) investigated whether oil price shocks have a
higher oil price volatility. She found that oil demand and supply shocks
greater impact on the rate of growth of GNP in an environment where
have a large and significant effect on the real price of the oil in the high
prices have been unstable than in a stable environment. To investigate
uncertainty regime.
this question they constructed a measure of oil price shocks –based on a
Summing up, methodological advances in the modeling and esti-
Generalized Autoregressive Conditional Heteroskedasticity (GARCH),
mation of uncertainty have deepened our understanding of the effect of
GARCH(1,1) model– that takes into account not only the magnitude but
oil price uncertainty on the U.S. economy in two important dimensions.
also the size of the forecast error. They found that positive shocks have
First, new empirical evidence points to a negative effect of unexpected
a negative effect on economic activity, whereas the effect of negative
increases in oil price volatility on aggregate economic activity, even if
shocks is statistically insignificant. Ferderer (1996), on the other hand,
the mean remains unchanged. Second, there appears to be a connection
used a daily oil price index to compute a measure of monthly oil price
between uncertainty regarding global economic activity and the vola-
volatility. He found that both the level and the volatility of oil prices
tility of oil prices. Third, an unresolved problem is that standard mea-
helped forecast the rate of growth of industrial production. Further-
sures of oil price uncertainty relate to short-horizons, whereas eco-
more, he found an asymmetric response of economic activity to oil price
nomic theory suggests that what matters is oil price uncertainty at
increases and decreases.
much longer horizons (see Kilian, 2014). For example, when extra-
The work of Lee et al. (1995) and Ferderer (1996) contributed to the
polating monthly or quarterly GARCH estimates of the conditional
literature on the effects of oil price shocks on the macroeconomy in two
variance to longer horizons, the conditional variance quickly converges
important aspects. First, it highlighted the importance of accounting for
to the unconditional variance. The latter is constant, so we would not
the effect of the volatility of oil prices in forecasting economic activity.
expect a large recessionary effect.
Second, it provided some empirical evidence in support of an asym-
metric relationship between oil price changes and output growth.
7.2. Oil price shocks and economic uncertainty
However, an important pitfall in these articles is the assumption that oil
prices are exogenous with respect to the U.S. economy. In contrast,
A recent and fast growing strand of literature has investigated the
Elder and Serletis (2010) relaxed this assumption and allowed for
effect of uncertainty shocks on aggregate economic activity. For in-
lagged feedback from the U.S. economy to the price of oil.
stance, Baker et al. (2016) developed an index of economic policy un-
Elder and Serletis (2010) estimated a bivariate GARCH-in-Mean
certainty based on the frequency of newspaper articles that contain
VAR with oil prices and aggregate economic activity. Their estimates
specific words related with economic policy uncertainty in the U.S.
are indicative of a negative and significant effect of heightened oil price
Following a similar strategy, Knotek and Zaman (2018) constructed an
uncertainty on U.S. real GDP. They also find some evidence that the
historical index of energy price news by computing the monthly fre-
negative impact of oil price volatility is greater for durable goods and
quency of articles in The New York Times that mentioned energy prices.
investment; this finding is consistent with the theories of investment
However, they interpret their NYT index as a measure of the informa-
under uncertainty and real options.
tion available to the consumer and not the measure of policy un-
Jo's (2014) work deviated from previous studies by modeling oil
certainty. Their paper started by estimating a multiple-regime threshold
price uncertainty as following a stochastic volatility process, instead of
vector autoregressive model, which comprises energy inflation, energy
a GARCH process. This allows the first and second moments of the oil
inflation excluding food and energy prices, and real consumption
price to have their own innovation and, then, for the time-varying oil
growth. Estimation results using a Bayesian framework suggest that a
price uncertainty to enter in the mean equations of the VAR. In addi-
model with two regimes (i.e., high and low energy inflation) is pre-
tion, her work differs from Elder and Serletis (2010) in that it tackles
ferred over a non-switching model. Moreover, the results provide evi-
the effect of oil price uncertainty on global instead of U.S. economic
dence of asymmetries and nonlinearities in the response of consumer
activity. Jo (2014) found that an unexpected increase in oil price vo-
spending to positive and negative energy price shocks. These asym-
latility that leaves unchanged the first moment of the oil price series
metries are more evident for large than for small energy price shocks.
would have a negative and persistent effect on industrial production. Jo
Knotek and Zaman (2018) proposed an information channel whereby
(2014) findings are consistent with earlier theoretical literature such as
oil price shocks could have an asymmetric effect on consumer spending.
Bernanke (1983). However, Jo (2014) findings are in contrast with
Namely, consumers are better informed about raises in oil price than
earlier empirical and theoretical literature (see, e.g., Plante and Traum,
regarding declines. The reason for this asymmetric flow of information
2014) as they indicate that oil price uncertainty on itself –not in con-
is found in the asymmetric news coverage provided for oil price in-
junction with an increase in the oil price level– has a detrimental effect
creases and decreases.
on industrial production growth.
The reader might wonder why oil price shocks might matter for
On a related topic, Kilian (2014) stresses that oil prices are an im-
economic policy uncertainty. On one hand, Baker et al. (2016) suggests
portant part of the expected cash flow of oil companies and oil re-
that heightened economic policy uncertainty can lead to lower invest-
fineries, but they are not an important part of the cash flow for man-
ment, employment and production. On the other hand, the work by
ufacturing companies. He suggests the reason why some studies find
Knotek and Zaman (2018) suggests that consumers might be more at-
seemingly large negative effects of higher oil price uncertainty on in-
tentive to news regarding energy prices when large oil price shocks hit
vestment by manufacturing companies is that oil price uncertainty may
the economy. If periods of higher oil prices come hand in hand with
reflect macroeconomic uncertainty.9
increased economic policy uncertainty, one could expect a future de-
cline in economic activity.
9
Oil and oil products are not an important part of cash flows of investment Along this line of reasoning, Kang and Ratti (2013) investigated the
for most companies (see Kilian, 2014). effect of structural oil price shocks on economic policy uncertainty

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using a structural VAR model similar to Kilian (2009b). They find that experienced by the price of crude oil have rekindled the interest of
shocks to oil production do not significantly affect economic policy policy makers and academics on the effect of oil price fluctuations. For
uncertainty, whereas shocks to global real aggregate demand have a instance, Baumeister and Kilian (2016) investigated the response of U.S.
negative effect on economic policy uncertainty. Moreover, their results real GDP to the sharp drop experienced by oil prices after June 2014.
suggest that positive oil price shocks associated with increased pre- They found that this decline resulted in increased real consumption and
cautionary demand for crude oil lead to a significant increase in U.S. non-oil related business investment, which gave rise to a 1.3% expan-
economic policy uncertainty. sion in GDP. Yet, this stimulus was largely offset by a decline of in-
Kang et al. (2017) disaggregate oil production shocks by origin, US vestment in the oil industry.
and non-US, and investigate their influence on US economic policy Herrera et al. (2017) exploration into the effect of oil price changes
uncertainty. They argue that US economic policy uncertainty responds on job reallocation during the period of the rapid shale expansion and
differently to these two types of shocks: an adverse US oil supply shock the subsequent decline in oil prices is consistent with Baumeister and
has a positive and statistically significant effect on economic policy Kilian (2016). Indeed, their study revealed that the oil price decline had
uncertainty, whereas a non-US supply shock has no significant effect. little impact on net employment; out of the 0.5% points change in the
We conclude this section by remarking that this new strand of lit- net employment between 2004:I and 2014:IV, oil price changes con-
erature on the connection between news, economic policy uncertainty tributed only 0.08% points. Interestingly, regardless of the changes in
and oil price shocks opens interesting avenues of research. In fact, the the U.S. economy and the crude oil market, Baumeister and Kilian's
renewed interest in understanding this link is not surprising given the (2016) and Herrera et al. (2017) investigations suggest that oil price
large swings in economic policy uncertainty (Baker et al., 2016) and the decline still fail to stimulate aggregate economic activity.
increased oil price volatility experienced around the Great Recession Karaki (2018a) studied the contribution of structural oil price
(Herrera et al., 2018). shocks on state-level unemployment during the shale boom period. He
found that among oil supply shocks, aggregate demand shocks, oil-
8. Have the effects of oil price shocks changed over time? specific demand shocks, and the unobserved shock in unemployment,
aggregate demand shocks contributed the most to explaining the
Since the oil price shocks of the 1970s bolstered a line of research changes in state unemployment rates for both oil producing and oil
into the macroeconomic effects of oil price changes, the crude oil importing states.
market has experienced important transformations. Oil futures started Have the effects of oil price shocks changed over time? There ap-
trading officially in the New York Mercantile on March 30, 1983. This pears to be ample evidence in the literature to suggest that this is the
event roughly coincided with the decline in volatility experienced by case. On the one hand, the effect of unexpected oil price increases on
the U.S. economy, commonly termed the Great Moderation. More re- the U.S. economic activity seems to have diminished since the mid-
cently, fracking has enabled oil producers to extract oil from tight 1980s. The reason why oil price changes might not shock as much as
formations and has considerably increased production in the U.S. (see earlier appears to be mainly related to a change in the composition of
e.g. Kilian, 2016, 2017). Thus, a number of studies have explored the the shocks (supply versus demand driven). On the other hand, will the
stability of the oil price-macroeconomy relationship since the mid- fracking revolution change the way in which oil price shock affect the
1980s. U.S. economy? We expect that as more data become available, re-
Among the papers that explore changes in the response of the U.S. searchers will be able to tackle this question and study how the changes
economy to oil price shocks after the Great Moderation, we highlight undergone by U.S. oil industry since the fracking revolution affect the
the work by Blanchard and Galí (2010) and Herrera and Pesavento response of the U.S. economy.
(2009). The former started by noting that episodes of high oil prices in
the late 1990s did not appear to have such a large impact on GDP 9. Conclusion and policy implications
growth and inflation as the oil prices shocks of the 1970s. To investigate
the nature of this apparent change, they first estimated a SVAR where This paper provided a survey of influential papers that investigated
oil price shocks are identified by assuming that they are predetermined the effect of oil price shocks on U.S. economic activity. First, we dis-
relative to the other macroeconomic variables and the model is esti- cussed the different theoretical channels through which oil prices op-
mated over two different sample periods, pre and post the Great erate. In particular, we revisited the direct and indirect supply and
Moderation. They found that the response of GDP growth, employment, demand channels that imply a symmetric/asymmetric response of
prices and wages in the post-1984 period was muted relative to the pre- economic activity to oil price increases and decreases.
1984 period, confirming similar results for private consumption re- We then reviewed the literature that seeks to disentangle the source
ported by Edelstein and Kilian (2009). Then, they used a new-Key- behind oil price fluctuations and, thus, demonstrates that supply and
nesian model with real wage rigidities where they analyzed three demand driven shocks should be identified separately. We highlighted
possible explanations: a decrease in real wage rigidity, an improved two insights derived from these studies. First, taking crude oil in-
monetary policy response to oil price shocks, and a decrease in the ventories into account is key for correctly identifying the effect of de-
share of oil in production and in consumption. Edelstein and Kilian mand driven shocks. Second, demand driven shocks account for a larger
(2009) and Kilian and Lewis (2011) provides compelling evidence percentage of fluctuations in oil prices than supply driven shocks.
against the two last explanations. In fact, work by Kilian (2008c), Kilian Then, we summarized the results from recent empirical studies that
(2009a), Kilian (2009b) indicates that changes in the importance of the investigated the effect of oil price shocks on U.S. real GDP, consump-
structural shocks underlying oil price fluctuations are the main drivers tion, investment and stock returns. We examined how the literature
of the decline in the responsiveness of U.S. real economic activity. evolved in the past 30 years and lead researchers to re-evaluate their
As mentioned earlier, Herrera and Pesavento (2009) explored the beliefs regarding the consequences of oil price shocks. For instance, we
contribution of better monetary policy in accounting for changes in the noted that the development of improved econometric techniques led
response of U.S. economic activity to oil price shocks since the Great researchers to re-evaluate the notion that oil price increases and de-
Moderation. Their work suggests that better monetary policy during the creases have an asymmetric effect on aggregate economic activity, as
Volcker-Greenspan era helped to dampen fluctuations in aggregate well as more disaggregate macroeconomic variables such as the com-
economic activity stemming for oil price shocks. As in Blanchard and ponents of GDP, stock returns and job flows. All in all, recent studies
Galí (2010), their study is based on splitting the sample at the time of indicate that the relationship between oil price shocks and U.S. ag-
the change and using time-invariant regressions. gregate economic activity is well captured by a linear relationship, but
The rapid increase in shale oil production and the recent swings some evidence of asymmetric responses is found at the more

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A.M. Herrera et al. Energy Policy 129 (2019) 89–99

disaggregated level, at least for large shocks. Dimensions of Monetary Policy, University of Chicago Press for the NBER, 373-421.
Moreover, our review expounded important developments in what Bodenstein, M., Guerrieri, L., Kilian, L., 2012. Monetary policy responses to oil price
fluctuations. IMF Econ. Rev. 60 (4), 470–504.
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