Monetary policies and oil price determination: an empirical analysis

• Author: Farhad Taghizadeh Hesary,Naoyuki Yoshino
• DOI: http://doi.org/10.1111/opec.12021
• Published date: 01 March 2014
• Date: 01 March 2014

Monetary policies and oil price

determination: an empirical analysis

Farhad Taghizadeh Hesary*,† and Naoyuki Yoshino**

*Research Fellow, School of Economics, KEIO University, Mita 2-15-45 Minato-ku, Tokyo108-8345, Japan.

Email: farhadth@gmail.com, farhadth@z3.keio.jp

**Professor of Economics, School of Economics, KEIO University, Mita 2-15-45 Minato-ku, Tokyo

108-8345, Japan. Email: yoshino@econ.keio.ac.jp

Abstract

While the oil price shocks of 1970s can be explained by pure supplyfactors, star ting in the 1980s oil

prices increasingly began to come under a different type of pressure. Oil prices accelerated from

about $35/barrel in 1981 to beyond $111/barrel in 2011. At the same time interest rates1subsided

from 16.7 per cent per annum to about 0.1. This paper explains how this long-term price increase

was, in most cases, caused by expansionary monetary policies that heightened oil prices through

interest rate channels. Aggressivemonetar y policies stimulated oil demand and blewup oil prices, a

trend that led to slowereconomic g rowth.As for elasticities, the results described in this paper show

that oil demand price elasticity is low value and unlike some earlier literature states, supply price

elasticity is statistically significant. In last section, the results show that oil prices adjust instantly,

declaring the existence of equilibrium in the oil market during the period from 1960 to 2011.

1. Introduction

A descriptive analysis of crude oil markets enables us to observe oil price movements

during two subperiods: 1960–1980 and 1980–2011. The initial period of 1960–1980 wit-

nessed a series of oil price shocks in which price hikes culminated in 1980 at a price of

$36.83/barrel in nominal terms from $1.9/barrel in 1960. Figure 1 illustrates cr ude oil

price movements in nominal and real terms during 1960–2011.

Figure 2 shows crude oil price growth rates in both real and nominal terms during the

period of 1960–2011 and exhibits that both prices followedthe same path.

The production of crude oil increased during the first period (1960–1980) at an

averagerate of 4.95 per cent, moving to a production rate of 59.4 million barrels/day (mbd)

in 1980 from 21 mbd in 1960 (Fig. 3). In contrast to the stable crude oil output growth

†Visiting Scholar, The Institute of Energy Economics, Japan (IEEJ), Inui Bldg. Kachidoki, 13-1

Kachidocki 1-chome, Chuo-Ku,Tokyo 104-0054, Japan.

JEL Classification: Q31, Q41, E52

1

© 2014 Organization of the Petroleum Exporting Countries. Published by John Wiley & Sons Ltd, 9600 Garsington

Road, Oxford OX4 2DQ, UK and 350 Main Street, Malden, MA 02148, USA.

before 1973, the first oil price shock in 1973 initiated recurrent changes in oil production

and a dissociation between OPEC and non-OPEC output. Figure 3 shows the remarkable

contrast in the behaviour of OPEC and non-OPEC production in the period after the first

oil price shock until 1985. From 1985 to 2011, however, both OPEC and non-OPEC output

movedalmost steadily parallel to each other. Figure 4 shows the growth rate of OPEC and

global crude oil output.

During the second period of 1980–2011, in the early 1980s, a recession reduced crude

oil demand and exerted significant downward pressure on oil prices. By the end of the

decade, prices had declined substantially to below$25 USD per bar rel.The 1990s brought

the Persian Gulf War (1990–1991), which had an impact on supply and prices as well.

Despite the low prices for crude oil for most of the 1990s, there was little interest

within OPEC to try to raise prices. This lack of action by OPEC kept oil prices low for

an extended period. However, when crude oil prices descended to $10 USD per barrel

Figure 1 Crude oil prices 1960–2011: Prices are in US dollars per barrel. 1960–1983: Arabian

Light posted at Ras Tanura 1984–2011: Brent dated. The dashed line is real price, and the solid line

is the nominal price.

Figure 2 Changes in log crude oil prices 1960–2011: The dashed line is the real price, and the solid

line is the nominal price.

Farhad Taghizadeh Hesary and Naoyuki Yoshino2

OPEC Energy Review March 2014 © 2014 Organization of the Petroleum Exporting Countries