Oil and Africa’s macroeconomy: are structural breaks important?

• DOI: http://doi.org/10.1111/opec.12161
• Author: Adeola Adenikinju,Iyabo Olanrele
• Published date: 01 December 2019
• Date: 01 December 2019

Oil and Africa’s macroeconomy: are

structural breaks important?

Iyabo Olanrele* and Adeola Adenikinju**

*Research Fellow, Economics and Business Policy Department, Nigerian Institute of Social and Economic

Research (NISER), Ibadan, Nigeria. Email: adeyemiyabo@yahoo.com

**Professor of Economics, Centre for Petroleum, Energy Economics and Law (CPEEL), University of

Ibadan, Oyo State, Nigeria. Email: adeolaadenikinju@yahoo.com

Abstract

This study examines the changing impact of oil price shocks on Nigeria and South Africa. Using a

structural break approach, recent studies have established the altered impact of oil price shocks

consequent to the Great Moderation that commenced in the mid-1980s. While several studies have

focused on the oil–macroeconomic relationship in Africa, little attention has been paid to the

variation across different periods. This study investigated the possible changing impact of oil on

inflation and the real gross domestic product growth rate in the two largest African economies that

are, respectively, net oil-exporting and net importing countries. A data set from 1970 quarter 1 to

2016 quarter 4 was employed. An impulse response function was used as a referenced model while

rolling impulse approach was adopted to ascertain variation across periods. Our findings show the

magnitude of the impacts of oil price shocks has declined significantly since the 1990s. Several

factors were adduced for the muted effects of oil in the two economies. These factors were largely

driven by domestic policies and institutional reforms. Hence, not taking account of the time-

varying nature of the relationship may not provide a complete picture of the relationships between

oil and macroeconomic outcomes among African countries.

1. Introduction

Over the last three decades, findings on the macroeconomic impacts of oil price shocks

have evolved. Prior to the 1980s, the effect of oil price shocks, irrespective of nature and

magnitude of shock, was found to be profound on both exporting and importing

economies. However, the oil price shocks of the 1980s compelled most affected

economies to look inwards for countercyclical policies to modulate the domestic impacts

of external shocks. The impacts of these policies have greatly moderated the effects of

oil price shocks since the 1980s (Blanchard and Gali, 2007; Gronwald, 2012).

However, for African countries, the exact macroeconomic impact of oil price shocks

remains uncertain given their relatively high reliance on oil imports and exports, as well

as the structural features of their economies. It is also a matter of empirical investigation

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whether the observed moderation effects in cross-country studies and for some

economies around the world in the last few decades are also similar in African

economies. It is possible that the effects may vary across African countries depending on

whether the country is a net oil exporter or importer. This is because the transmission

mechanisms of oil price shocks vary across different types of economies. In importing

countries, oil price shocks affect the balance of payment through the import bills (Khan,

1993), while higher international oil prices are also passed-through to the domestic

inflation rate. There is high fiscal dependence on the oil sector in most oil-exporting

countries. The oil sector is the dominant source of government income, as well as a

major source of foreign exchange earnings and foreign reserves. Oil price shocks,

therefore, impact directly on the government’sfiscal performance, as well as broader

fiscal and monetary policies. (Rosser and Sheehan, 1995). Also, oil price fluctuations,

through oil export receipt transmits to the real exchange rate, thereby, affecting

aggregate output (Mehrara and Mohaghegh, 2011). Therefore, any form of oil price

shock could significantly impact domestic macroeconomic outcomes and performance.

A large body of literature exists in the broad thematic area, but only a few considered

the role of structural breaks in explaining the relationship in African emerging

economies. Hence, the conclusion from such studies may not capture a full

understanding of the oil price shocks–macroeconomic relationship. The most widely

adopted approach, using the full-sample method, leaves out salient features over the

study period, including regime/structural shifts. Also, findings are inconclusive as

evidence remains mixed and contradictory. Some of the studies reported a profound

effect of oil price shocks on the macroeconomy, and others came up with results that

show that the relationships are not significant.

Our specific objective in this paper was to examine the changing impacts of oil price

shocks on the domestic macroeconomy of the two largest economies in Africa—Nigeri a

and South Africa. The major macroeconomic indicators employed in the paper are output

growth, measured by real GDP growth rate, and inflation rate, proxy by CPI inflation.

The net oil specification was adopted as a measure of oil prices hocks.

1

This is because

the effect of oil shocks is established to be non-linear considering the incidence of both

positive and negative oil price shocks (Hamilton, 1996). To facilitate a robust analysis

and result comparison, we use the conventional impulse response (full-sample)

technique. This serves as a benchmark model to examine the macroeconomic effects

of oil price shocks. Of main concern in this study is the sub-sample approach, which is

based on the rolling impulse response (RIR) technique. The RIR technique is used to

explore the nature of dynamic responses of the macroeconomy to oil price shocks

(Blanchard and Gali, 2007; Gronwald, 2012). It is an unrestricted way of analysing

parameter changes and instability over time. According to Blanchard and Gali (2007),

cited in Gronwald (2012), the RIR in contrast to other techniques has some potentials of

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430 Iyabo Olanrele and Adeola Adenikinju