What is new? The role of asymmetry and breaks in oil price–output growth volatility nexus

• Author: Ibrahim D. Raheem,Nafisat O. Olabisi
• Published date: 01 March 2019
• DOI: http://doi.org/10.1111/opec.12142
• Date: 01 March 2019

What is new? The role of asymmetry and

breaks in oil price–output growth volatility

nexus

Ibrahim D. Raheem* and Nafisat O. Olabisi**

*Centre for Econometric and Allied Research, University of Ibadan, Ibadan, Nigeria. Email:

i_raheem@ymail.com

**Department of Economics, University of Ibadan, Ibadan, Nigeria.

Abstract

This study examines the role of asymmetry and breaks in oil price–output growth volatility nexus.

A representative of 10 countries was selected from net oil-exporting and-importing economies for

the period 1986–2017. It is hypothesised that countries respond differently to changes in oil price.

To prove this point, we use the recent nonlinear ARDL of Shin et al. (2014), based on the

framework of the dynamic common correlated effect of the heterogeneous panel of Chudik and

Pesaran (2015), to decompose oil price into positive and negative partial sums. Our results show

that without accounting for breaks, asymmetry only matters for net oil exporters in both short- and

long run. However, accounting for breaks expanded the importance of asymmetry to net oil

importers (in the short run). These results are robust to changes in the measures of oil price and

growth volatility.

1. Introduction

Among the macroeconomic (monetary) policy objectives of economies around the world

is to attain stable and predictable trend of economic growth. There has been a paradigm

shift in the frontier of knowledge of development economics. Early studies have based

their argument on economic growth, while a later set of studies have argued for the

importance of accounting for business cycle. What is more, Ramey and Ramey (1995)

estimated a negative relationship between economic growth and its volatility. Based on

this identified importance of business cycle, several studies have made enormous

attempts to understate the causes, nature and solution of this cycle. Essentially, studies

have based scientific enquiries to identifying variables that have either dampening or

magnifying influence on output growth volatility (business cycle).

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In a different approach, although common in the literature, we have identified oil

price shock to have an important effects on economic activities and macroeconomic

fundamentals. In this line of reasoning, the major argument is due to the epoch-making

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paper of Hamilton (1983) who argues that oil price shocks have ‘predictive content’on

economic activities and macroeconomic policies of developed countries. Hamilton

(1983) and succeeding studies,

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posit that a huge and sudden increase in oil prices

precede recession and also increases the inflation rate in the United States. It can be

summarily stated that the Hamilton and his followers assume a symmetry relationship

between oil price shocks and economic activities.

The dominance of these symmetry studies was short-lived. The followings are the

flaws and criticisms offered in the literature. The major criticism dwells on their

(symmetry based studies) inability to account for asymmetry. For instance, all but one of

the five major recessions in the United States, between the end of World War II and

1973, were preceded by oil price rise. Barsky and Kilian (2002) argue that the major oil

price changes in the 1970s were not the main cause of stagflation but due to monetary

factors. Mork (1989) pinpointed that the mere fact that oil price increase has negative

effects on growth does not necessarily mean oil price reduction would lead to economic

growth, at least for the United States. Of specific importance is the failure of oil price

collapse, in 1986, to translate into economic growth, hence, it serves as a pointer to the

asymmetry effect. Mork et al. (1994) conclud ed that asymmetry effect is present in most

OECD countries. In fact, Lee et al. (1994) expressed that the increasing oil price

volatility contributed to the asymmetric effect especially when economic activities are

being deflated by oil price volatility. Hooker (1996) concluded that the linear

relationship between oil price and the economy appears to be much weaker after

1973. As such, the symmetry relationship appears to be a mere illusion. Interestingly,

another source of flaw for the symmetry and by extension advantage of asymmetry is

based on ignoring the effect of 1986 Tax Reform Act (in the United States) on fixed

investment and the aggregation of energy and non-energy–related investment (see

Edelstein and Kilian, 2007 and 2009).

Based on the foregoing, it has become imperative for studies to test for the existence

of asymmetry when modelling oil price. Thus, the crux of this present study is twofold.

The first objective is to check if oil price shock serves as a plausible candidate to have a

significant effect (dampening or magnifying) on business cycle, an important macroe-

conomic policy objective. If the above is confirmed, we proceed to the second objective,

which is to examine the asymmetric effect (if any) of oil price shocks on output growth

volatility. Thus, we examine both the short- and long-run effects of oil price shock on

economic growth using the partial sum decompositions of the Shin et al. (2014)

NARDL framework. The NARDL is further complemented with the dynamic common

correlated effect estimator of Chudik and Pesaran (2015).

This study presents two novelties to the literature. First and in contrast to the norm of

earlier literature to focus on the United States, we expanded our scope to account for not

only net oil-exporting countries but also for net oil-importing countries. The aim of this

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68 Ibrahim D. Raheem and Nafisat O. Olabisi