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MAY 02, 2016
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Lower Oil Prices and U.S. Economic

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Jan Groen and Patrick Russo
About the Blog
Liberty Street Economics features insight and analysis
from New York Fed economists working at the
intersection of research and policy. Launched in 2011,
the blog takes its name from the Bank’s headquarters
at 33 Liberty Street in Manhattan’s Financial District.

The editors are Michael Fleming, Andrew Haughwout,

Thomas Klitgaard, and Asani Sarkar, all economists in
the Bank’s Research Group.

The views expressed are those of the authors, and do

After a period of stability, oil prices started to decline in
not necessarily reXect the position of the New York
mid-2015, and this downward trend continued into early
Fed or the Federal Reserve System.
2016. As we noted in an earlier post, it is important to
assess whether these price declines reflect demand shocks
or supply shocks, since the two types of shocks have Economic Research Tracker
different implications for the U.S. economic outlook. In this
post, we again use correlations of weekly oil price changes Liberty Street Economics is now
with a broad array of financial variables to quantify the available on the iPhone® and
drivers of oil price movements, finding that the decline iPad® and can be customized by
since mid-2015 is due to a mix of weaker demand and economic research topic or
increased supply. Given strong interest in the drivers of oil economist.
prices, the oil price decomposition is information we will be
sharing in a new Oil Price Dynamics Report on our public
website each Monday starting today. We conclude this post
using another model that finds that the higher oil supply View by Topic
boosted U.S. economic activity in 2015, though this impact
is expected to wear off in 2016. BANK CAPITAL BALANCE OF PAYMENTS BANKS
CENTRAL BANK CORPORATE FINANCE CREDIT CRISIS
As described in our post last year, we use a model to CRISIS CHRONICLES CRYPTOCURRENCIES
distinguish demand and supply shocks on oil prices based CURRENT ACCOUNT DEALERS DEMOGRAPHICS
on correlations of oil price changes with a large number of DODD-FRANK DSGE ECONOMIC HISTORY EDUCATION
financial variables. We updated the model here using data EMPLOYMENT EURO AREA EXCHANGE RATES
through late April 2016. The chart below shows oil price
EXPECTATIONS EXPORTS FED FUNDS FEDERAL RESERVE
changes along with the model-implied supply and demand
FINANCIAL INSTITUTIONS FINANCIAL INTERMEDIATION
drivers of prices cumulated from early June 2015 (when the
last post was published) to late April 2016. The initial fall in FINANCIAL MARKETS FIRE SALE FISCAL POLICY FOMC
oil prices between early June and early August was due FORECASTING FORECLOSURE GREAT RECESSION
mainly to supply factors, while the subsequent drop-off into HEY, ECONOMIST! HIGH FREQUENCY TRADING
September was demand-driven (due largely to China-
related global financial market turmoil in August). Demand
was again a large contributor to the drop in oil prices at the
end of last year.
The next chart zooms in on the oil price developments from
early October 2015 to late April 2016, focusing on oil price
changes and identifying demand and supply contributions
in this period. This illustration clarifies that the pull on oil
prices over the course of the fourth quarter was due to
oversupply concerns, with increased expectations that the
oil export restrictions for Iran would be lifted. In January,
global demand perceptions following a renewed meltdown
in Chinese financial markets drove oil prices further down.
More recently, however, with the easing of global economic
and financial uncertainty, reassessments of global demand
expectations have pushed oil prices higher.
So, what are the implications of these oil price
developments for U.S. economic activity? We use a
statistical model incorporating contemporaneous and
lagged data for GDP growth, real PCE growth, and real
nonresidential business fixed investment spending growth
(split up into oil and mining sector and non-oil investment
spending) plus some additional variables to identify the
impact of oil supply shocks on the economy. Our estimated
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HOUSING HUMAN CAPITAL INEQUALITY INFLATION
INTERNATIONAL ECONOMICS LABOR ECONOMICS
LABOR MARKET LENDER OF LAST RESORT LIQUIDITY
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NEW JERSEY NEW YORK NEW YORK CITY PANIC
PHILLIPS CURVE PUERTO RICO RECESSION
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supply component of oil price changes then becomes an
instrumental variable for the unexplained part of the model
(the residuals), helping us identify the macroeconomic
implications of oil supply shocks.

We estimate the impact of the model-identified supply

shocks on GDP, as well as its two main components,
consumption and nonresidential business fixed investment
spending (aggregated from the separate oil and mining and
non-oil components). The panel of three charts below shows
actual (annualized) growth rates (the blue lines), simulated
growth rates using our model and assuming no additional
shocks after the first quarter of 2016 (the gray lines), and
the contribution of our oil supply shocks to these actual and
simulated growth rates (the gold lines).

The expansionary oil supply shocks of the fourth quarter of

2014 and the first quarter of 2015 appear to contribute to
about a third of the GDP growth in the first half of 2015,
whereas the positive supply shocks of the second half of last
year had a relatively larger positive contribution (albeit GDP
growth slowed down over this period). Going forward,
however, our model suggests that the contribution of these
supply shocks dissipates fairly rapidly in 2016 and is
estimated to be essentially zero from the second quarter of
2016 onward.

Turning to the middle chart in the panel below, we see that

the 2014-15 expansionary oil supply shocks contribute, on
average, to about half of the observed growth rate in
consumption in 2015. And despite the contraction of oil-
related investment spending, positive oil supply shocks are
a main driver of nonresidential investment spending growth
throughout the first half of 2015, but not for the final
quarter of 2015 and the first quarter of this year, as can be
seen in the bottom chart.
Our analysis suggests that excess supply was a significant
driver of oil price weakness over the past year, although it
was not a dominant determinant like in the second half of
2014. For the first quarter of 2016, the oil price
decomposition did suggest a relatively stable supply and
this implies little impact from oil prices on overall economic
activity in the rest of this year.

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Disclaimer
The views expressed in this post are those of the authors
and do not necessarily reflect the position of the Federal
Reserve Bank of New York or the Federal Reserve System.
Any errors or omissions are the responsibility
of the authors.

How to cite this blog post:

Jan Groen and Patrick Russo, “Lower Oil Prices and U.S. Economic Activity,”
Federal Reserve Bank of New York Liberty Street Economics (blog), May 2, 2016,
http://libertystreeteconomics.newyorkfed.org/2016/05/lower-oil-prices-and-us-economic-
activity.html.

Posted by Blog Author at 07:00:00 AM in Exports, Financial Markets, International Economics,

Macroecon

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