The macroeconomics outcome of oil shocks in the small Eurozone economies

• Author: Raphael Raduzzi,Antonio Ribba
• Date: 01 January 2020
• DOI: http://doi.org/10.1111/twec.12862
• Published date: 01 January 2020

World Econ. 2020;43:191–211. wileyonlinelibrary.com/journal/twec

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191

© 2019 John Wiley & Sons Ltd

Received: 7 March 2019

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Revised: 25 June 2019

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Accepted: 5 August 2019

DOI: 10.1111/twec.12862

ORIGINAL ARTICLE

The macroeconomics outcome of oil shocks in the

small Eurozone economies

RaphaelRaduzzi

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AntonioRibba

Department of Economics Marco Biagi,University of Modena and Reggio Emilia, Modena, Italy

KEYWORDS

business cycles, Euro area, near‐structural VARs, oil shocks

1

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INTRODUCTION

Recent years have experienced, once more, a large turmoil in the oil market. For, during the second

semester of 2014, oil was still being sold at 110 dollars per barrel, but by the end of 2015, the same

commodity had lost more than 60% of its previous value and was traded at the minimum of 40 dollars

per barrel. Even now, despite the recent price recovery, oil is still quoted between 50 and 60 dollars

per barrel. Indeed, as stressed by Kinda, Mlachila, and Ouedraogo (2018), adverse commodity price

shocks may cause financial problems for commodity exporters.

This sharp decline might be ascribed to factors acting through both supply and demand channels,

and in fact researchers underline different aspects of the issue. Increased US production due to invest-

ments on fracking, sustained production in Libya and Iraq in spite of the unrests in these countries, the

suppression of economic sanctions against Iran and, further, the stagnating European demand jointly

with the slowdown of the Chinese economy all appear to be important factors capable of explaining

the recent sharp decrease in oil prices.

Demand‐side elements are, for instance, at the core of Baumeister and Kilian (2015). In this recent

article, the authors argue that the lower global economic activity of late 2014 is the main driver of

the current movements in the price of oil. Others, like Davig, Melek, Nie, Lee Smith, and Tuzemen

(2015), address the question to what is called "precautionary demand," that is the expectations over

future supply and demand conditions, as news of persistently high future production might lower this

kind of demand.

In the light of the important role played by oil prices for macroeconomic instability in industri-

alised economies, Kang and Ratti (2013) have recently investigated the relation between structural oil

shocks and policy uncertainty in the US economy.

Oil shock effects have in fact been investigated since the first price rallies of the seventies (Hamilton,

1983). However, old but still open important macroeconomic questions, also in the light of the recent

collapse of oil prices, are: how strong will the boost for GDP be? How long is the downward pressure

on inflation going to last?

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RADUZZI AnD RIBBA

In this paper, we investigate the macroeconomic outcomes of oil shocks in a group of small open

Euro‐area countries in the European Monetary Union (EMU) period. Indeed, there is a huge literature

studying the effects of oil price shocks for the US economy, and to a lesser extent for OECD coun-

tries, but only very few papers have investigated the dynamic effects of oil price shocks in the national

economies of the Eurozone.

Thus, in the present work we try to fill this gap in the current literature by providing an analysis

of the effects of oil shocks on the price level and on GDP for the small economies that founded the

Eurozone. These countries include Austria, Belgium, Finland, Greece, Ireland, Italy, Netherlands,

Portugal and Spain. Our data set, based on quarterly data, goes from 1999 to 2015.

In fact, to our knowledge, this is the first attempt to characterise the macroeconomic outcomes of

movements in oil prices in a large set of Euro‐area countries since the introduction of the euro.

For this purpose, we make use of a structural near‐VAR (vector autoregression) model in the spirit

of Cavallo and Ribba (2015). This near‐VAR structure implies that a first group of equations, that is

the exogenous block, only includes the lags of the oil price and Euro‐area variables. Instead, the sec-

ond block consists of full VAR equations, since it also includes national variables. In addition, in order

to control for the global business cycle, we employ as exogenous variable the economic activity index

developed by Kilian (2009). The structural disturbances are identified by imposing a causal structure,

with contemporaneous restrictions in a Cholesky fashion.

It should be noted that this representation has the implication that each country is subject to the

same set of oil and Euro‐area shocks. Nevertheless, it is also important to stress that our assumption is

that there is unidirectional Granger causation going from the Euro‐area variables to the national ones.

For this reason, we exclude from our analysis large economies such as France and Germany for which

the same hypothesis is somewhat more difficult to sustain.

It is worth noting that in very recent years, there has been a renewed interest among researchers

towards the structural near‐VAR methodology (see, among others, Boeckx,Dossche, & Peersman,

2017; Cavallo & Ribba, 2015; Givens & Reed, 2018). In some cases, this methodology has been

applied to economic questions regarding the Euro area. We believe this renewed interest is due to the

ability of near‐VARs to allow the interaction of area‐wide variables and local variables, while keep-

ing the number of included macroeconomic series reasonably low and while allowing the selection

of an invariant set of area‐wide shocks. Nonetheless, the other side of the coin is that the near‐VAR

methodology works quite well with small open economies interacting with large economies, but has

intrinsic limits when dealing with the interaction between large open economies. For example, it

would be difficult to justify the block exogeneity restriction in the case of Germany and, though to

a lesser extent, in the case of France. Indeed, these two countries were not included in our current

investigation. However, in this paper we also estimate the dynamic effects of oil shocks on prices and

GDP at the aggregate Euro‐area level and it is worth recalling that Germany and France make up

around half of the Euro‐area GDP.

Our findings show that oil price innovations transfer their effects on the consumer price index (CPI)

very rapidly in the Euro area. The estimated maximum effect on CPI of a 10% unexpected increase

in oil prices goes from 0.17% in Austria to 0.64% in Greece. On the other hand, the negative conse-

quences on GDP come with some more delay but they are rather persistent in almost all countries.

Thus, one of the main results of the present research, to be added to the literature on oil–macro-

economy relationship, consists in showing that despite the structural changes undergone by these

economies in the last decades (e.g. the adoption of the single currency and the related impossibility

for national economies to regain competitiveness through devaluation; increasing flexibility in labour

and goods market), oil shocks still matter in Euro‐area countries and continue to play a notable role in

driving business cycle fluctuations.