Oil Price Uncertainty and Industrial Production

We estimate a bivariate GARCH-in-Mean VAR with a BEKK variance specification, to investigate whether oil price volatility affects real economic activity. We use the same data set of thirty seven, aggregate and disaggregate, industrial production indices used by Herrera et al. (2011) as a proxy for real output and a post-1973 data sample. We check the robustness of our results by using two proxies for the price of oil, the West Texas Intermediate (WTI) oil price and the Refiners’ Acquisition Cost (RAC) of crude oil, and by testing for both nominal and real effects. We find significant evidence of nonlinearities for both aggregate and disaggregate indices. Our research highlights the importance of nominal prices and extreme events such as the Great Recession in the transmission of nonlinearities. Our results show that nonlinear impacts of the price of oil on the aggregate economy vary according to time period even within the post-1974 data. Since 2000, oil price volatility is up markedly, but the number of industries it impacts is down when compared with the full sample. This is in keeping with what one would expect, based on trend improvements in GDP per unit of energy use. However, for those series, where oil price volatility is significant, the impact of oil volatility is substantially higher than in the full sample; this runs contrary to what one might expect from the observed GDP per unit of energy use improvements.(This abstract was borrowed from another version of this item.)