The relationship between oil price fluctuation and vietnams macro economy

INSTITUTE OF SOCIAL STUDIES
THE HAGUE
THE NETHERLANDS

UNIVERSITY OF ECONOMICS
HO CHI MINH CITY
VIETNAM

VIETNAM - NETHERLANDS
PROGRAMME FOR M.A IN DEVELOPMENT ECONOMICS

THE RELATIONSHIP BETWEEN OIL PRICE FLUCTUATION
AND VIETNAM'S MACRO-ECONOMY

•
•

BY

LE THUANBINH

MASTER OF ARTS IN DEVELOPMENT ECONOMICS

HO CHI MINH CITY, June 2011


UNIVERSITY OF ECONOMICS
HO CHI MINH CITY
VIETNAM

INSTITUTE OF SOCIAL STUDIES

THE HAGUE
THE NETHERLANDS

VIETNAM -NETHERLANDS
PROGRAMME FOR M.A IN DEVELOPMENT ECONOMICS

THE RELATIONSHIP BETWEEN OIL PRICE FLUCTUATION AND
VIETNAM'S MACRO-ECONOMY

A thesis submitted in partial fulfilment of the requirements for the degree of
MASTER OF ARTS IN DEVELOPMENT ECONOMICS

By

LETHUANBINH

Academic Supervisor:

DR. DINH CONG KHAI

HO 'CHI MINH CITY, June 2011


ACKNOWLEDGEMENT
First of all, I would like to express my deep gratitude to my supervisor, Dr. Dinh
Cong Khai, for his encouragement and willing supports during the thesis writing
process.
I would like to give thanks to Mr. Phung Thanh Binh, who had provided sources of
data and instructed econometric techniques for my thesis.
I wish to express my gracefulness to the Vietnam-Netherlands Programme for M.A in

Development Economics which provides us chance to access the best conditions for
our study. I am in debt of all staffs of the Programme for their devoted supports
during the time I studied there.
I am graceful to all professors who devoted their enthusiasm and knowledge on ·
lectures from which we have benefited greatly. What I have learned from these
lectures not only help me have basic knowledge for doing this thesis but also provide

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me profound understanding on economics particularly and life generally .

.

I owe many friends a debt of gratitude for all their encouragement. I am graceful to
all my classmates for their co-operations during the course.
Last but not least, I am greatly indebted my family. My parents, especially my Mom
always encourage me and save all their love to me unconditionally.


CERTIFICATION
I certify that the substance of this thesis has not been submitted for any degree and is
not being currently submitted for any other degree.
This thesis is the result of my own independent work with the guidance of the
supervisor, except where otherwise stated. Other sources are acknowledged by
explicit references.

LE THUAN BINH

June,2011

..


ABSTRACT

The impact of oil price shocks on the macro-economy has received a great deal of
attention since the 1970s. Many empirical studies found a significant positive effect
between oil price shocks and consumer price index (CPI), and this higher CPI will
retard GDP. A key feature of this paper investigates the relationship between the
world oil price and Vietnam's macro-economy based on monthly time series dataset
from 2001 Q 1 to 2009Q4 , using the method of multivariate vector autoregression
(VAR). The findings show that the world oil price affects the economic growth and
inflation of Vietnam significantly. The results of the Granger causality test, impulse
response functions, and variance decomposition analysis all showed that an increase
in oil price will cause positive relationship to consumer price index, and this higher
consumer price index causes negative affect on GDP .

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TABLE OF CONTENTS
CHAPTER I: INTRODUCTION
1.1. Problem Statement ................................................................................... 1
1.2. Research Objectives ................................................................................. 4
1.3. Research Questions ................................................................................... 5
1.4. Research Methodology ............................................................................. 5
1.5. Thesis Structure ....................................................................................... 5

CHAPTER II: LITERATURE REVIEW
2.1. The relationship between oil price and inflation ..................................... 6

2.2. The relationship between oil price and industrial production .................. 6
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2.3. Six oil shocks in history ........................................................................... 7

.

2.3 .1. Crude oil price in the Middle East in period 1973-1975 ............... 7
2.3.2. Iranian revolution and oil price fluctuation in 1979 ...................... 8
2.3.3. The severe fall of oil price in 1980s .............................................. 8
2.3.4. Oil price shock in 1990 .................................................................. 9
2.3.5. The downtrend of oil price in 2001 ............................................... 9
2.3.6. The tremendous oil price shock in 2007-2008 .............................. 9
2.4. How higher oil prices affect the global economy .................................... 10
2.4.1. Quantifying the impact of oil price in OECD countries ................ 11
2.4.2. Quantifying the impact of oil price in developing countries ......... 13


2.5. Why oil seems to be a matter to the macro-economy .............................. 15
2.6. Empirical studies ....................................................................................... 19

CHAPTER III: RESEARCH METHODOLOGY
3.1. Methodology- Econometric techniques .................................................. 27
3.1.1. Stationary and Unit-root tests ....................................................... 27
3.1.2. Granger Causality Test .................................................................. 28
3.1.3. Impulse response functions ........................................................... 30
3.1.4. Variance decomposition ................................................................ 31
3.2. Model Specifications ................................................................................ 31
3.3 Variable Introduction and Data Description .............................................. 31

CHAPTER IV: RESEARCH RESULTS
4.1. Unit Root Tests ........................................................................................ 33
4.2. Granger Causality Tests ........................................................................... 36
4.3. Impulse Response Functions ...................................... ~ ............................ 37
4.4. Variance Decomposition .......................................................................... 38

CHAPTER IV: CONSLUSION
5.1. Conclusion ............................................................................................... 39
5.2. Policy Recommendation .......................................................................... 40


5.3. Suggestion for Fmiher Study ................................................................... 41
REFERENCES .............................................................................................. i-v
APPENDICES ............................................................................................... a-1

APPENDIX 1 ................................................................................................... a
APPENDIX 2 ................................................................................................... d
APPENDIX 3 ........................................................ .- ......................................... i
APPENDIX 4 .................................................................................................. j
APPENDIX 5 ................................................................................................... k
LIST OF FIGURES

Figure 1.1: Relationship between oil price and CPI in Vietnam from 1998-2009
Figure 4.2: The relationships of variables
LIST OF TABLES

Table 2.4.1: OECD macroeconomic indicators in sustained higher oil price case with
oil price assumed to be $10 per barrel higher than in base case
Table 2.4.2: Oil-importing developing countries macroeconomic indicators in sustained
higher oil price case after one year

Table 2.5.1: The coincidence of oil dates and recessions after 1972
Table 2.5.2: Growth in Total Factor Productivity and the Real Price of Oil Imports
Table 2.6: Summarization of the impact of oil price on economy
Table 4.1.1: Stationary test for variables in level
Table 4.1.2: Stationary test for variables ofCPI, IP, OP, and Ms in first difference
Table 4.1.3: Stationary test for variable of IP in second difference


CHAPTER I: INTRODUCTION
1.1 Problem statement:

In most of countries all over the world, oil industry plays critical roles in industrial,
economic and social activities. The relationship between oil price and levels of
economy activities has been the topic for discussion, because the oil price increases are
absolutely different from increases in prices of other goods. The first reason is that oil
price usually increases sharply or keeps sustainable, not typically of other goods and
services. The second one is that demand for oil is fairly inelasticity; due to oil is the
input of almost industries' output. The third one is that oil price fluctuations seem to be
dependent on the exogenous factors such as revolutions in the Middle East. Finally, oil
price fluctuations have been affected by abnormal economic change, and the
consequences ofhigher price are recession, high unemployment, and inflation.
Hamilton ( 1983) and Mork ( 1989), who are pioneers, researched the impact of oil price
shocks on economic activity. They found that GDP is negatively affected by oil price
shock and this was used as evidence that oil shocks are related to economic recessions.
Brown (2004), Schneider (2004), Lardic and Mignon (2006), Sill (2007) found that the
supply effect to demand effect and the terms of trade effect is altered variously in terms
of the transmission mechanisms of oil shocks to economy. On the supply side, a
reduction in inputs for production occurs in case of increased oil prices and this leads
to higher production costs, and it results a slowdown of productivity and output. On the
demand side, the oil price increasing puts prices of other goods in higher level, and it

makes people more consider with their consumptions; so demand falls. On the terms of
trade side, the worsening trade conditions have to be faced with fallen demand in oilimporting countries and this result in wealth transfer from oil-importing to oilexporting countries.


Jimenez-Rodriguez and Sanchez (2005) found that larger impact on gross domestic
product (GDP) is caused by an increase in oil price than a fall in oil price in the study
on selected OECD countries. Their study shows the United Kingdom's GDP is
negatively impacted by an increase in oil price in the oil exporting countries, while the
oil importing countries except for Japan has the same result.
A negative relationship between oil price and economic growth is also found in the
research of Kim and Willett (2000), who examined the relationship between oil prices
and economic growth for various panels of OECD countries. The same result also was
pointed out by Glasure and Lee (2002) in their study on Korea.
Therefore, it is important to understand ·impact of oil price on GOP in Vietnam for
purpose of stabilizing Vietnamese economic development.
Last but not least, an increase in oil price seems to lead the higher inflation. In fact,
there are a lot of empirical evidences attempted to examine the positive relationship
between oil price and inflation. By applying vector auto-regressions (VARs ), Burbidge
and Harrison (1984) estimated the impact of oil prices in Canada, Japan, West
Germany, the UK and the USA on consumer price index with data from 1961 to 1982.
They found that consumer price index and oil price have positive relationship in
Germany and Japan, and larger effect in the UK. By using Phillips curve framework,
Hooker ( 1999) prove that inflation is affected by oil price changes only through their
direct share in a price index, with little or no pass-through into core measures, while oil
shocks played decisive role to core inflation before 1980. Blanchard and Gali (2007)
used VAR model to similarly found that most rich countries had suffered strong impact
by oil price rises over 1970-1983, but very little effect on inflation in West Germany
and in Japan.
With the advent of the policy of reform, Vietnamese economy has taken off since
1986. Vietnam has been able to achieve a consistently high level of GDP on average

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8.6 percent a year and effectively address the problem of poverty. As a main sector
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contributing up to 26% Vietnam's GDP, oil industry plays very important role in the
whole Vietnamese economy. According to BP Statistical Review of World Energy, in
June 2009 Vietnam's proven oil reserves were 4.73 billions barrels. The annual Oil and
Gas Journal survey takes a much more cautious approach, suggesting just 600 millions
barrels of proven reserves at the end-2009. As an oil exporter of refined petroleum
products till 2010, Vietnam is potentially vulnerable to oil price volatility. When the
global oil price goes up, Vietnamese government has to find out the way to tackle
inflation. In 2008, the oil price got the peak price $145 per barrel, the inflation in
Vietnam also sky-rocketed to 26.4 percent which is a unprecedented number and
among the top highest of the world at that time. The price of essential food increased
by 72.2 percent. The country has a vast amount of oil reserves but it has not owned
refinery factories yet. Therefore, the nation spends approximately 7.8 billion dollars to
buy refined petroleum products. The number rose by 90.7 percent while the global
energy price has been rising. The authority has decided to increase the retail price by
30 percent, which has caused more serious inflation . Vietnam used to be described as
one of the economic tigers, but has been defeated by the intense inflation for the past
few years. The matter has become a controversial issue which attracts many analysts to
spend their time to research. In addition, the government has also made a lot of efforts
and acted drastically to resolve the problem, but it has not stopped and kept on causing
long-run effects. This relationship is described in below table with the steady increase
of CPI- the core of inflation.

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Firuge 1.1. Relationship between oil price and CPI in Viet11am from 1998-2009

.
180
160
140
120
100

--+-Oil price
-CPI

80
60
40
20
0
9

17

25

33

41

49

57

65

73

81

89

97 105 113 121 129 137

Source: Author's calculation.

For the result, to examine impact of oil price on GDP and inflation in Vietnam is very
important to effectively deal with rising price at a time when the surging oil cost occurs
and to get a grip on inflation for stable development target.

1.2 Research objectives:
The overall goal of this thesis is to test the impact of oil prices on inflation and GDP.
To meet this overall goal, the thesis will meet the following objectives:
(i)

To study effect of oil price change on inflation.

(ii)

To study the effect of oil price change on GDP.

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1.3 Research questions:

In order to obtain the above objectives, the thesis will attempt to answer the following
questions:
1) Does an increase in oil price cause inflation?
2) Does oil price fluctuation affect GDP ofVietnam?

1.4 Research methodology:

This thesis will apply the Vector Auto Regression (V AR) model with monthly time
series dataset from 2001 Q 1 to 2009Q4, with the following indicators: world oil price,
consumer price index, industrial production, money supply and interest rate, taken
from International Monetary Fund's (IMF) International Finance Statistic (IFS), the
website of International Energy Agency (lEA) and Vietnam General Statistic Office
(GSO) to examine the impact of oil price increase on inflation and industrial
production.

1.5 Thesis structure:

The thesis is organized m four chapters. Chapter I is introduction. Chapter II is
literature review and empirical studies. Chapter III is research methodology. Chapter
IV is empirical results. Chapter V includes conclusions and policy recommendation.

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CHAPTER II: LITERATURE REVIEW AND EMPIRICAL EVIDENCES

2.1 The relationship between oil prices and inflation

The oil price and inflation are usually seen as being connected in a cause and effect
relationship. Playing as the main input of most industry, an increase of oil price leads
to the increase of cost of end product. Therefore, the fluctuation of oil price and
inflation usually has the same trend. For example, if the oil prices go up, then the
transportation company will increase the price of ticket; in other words the
transportation fees will move up, so passengers or the consumers have to pay more and
inflation occurs. The direct relationship between oil and inflation was evident in the
1970s, when the cost of oil rose from a nominal price of $3 before the 1973 oil crisis to
around $40 during the 1979 oil crisis. This helped cause the consumer price index to
more than double from 41.20 in early 1972 to 86.3 by the end of 1980. However, the
relationship between oil and inflation started to deteriorate after 1980s. During the
1990's Gulf War oil crisis, crude prices double in six months from around $20 to $40
per barrel, but CPI remained relatively stable.

2.2 The relationship between oil prices and industrial production

In some years ago, the relationship between oil prices and industrial production have
been examined extensively in numerous studies. Komain (2006) applied Johansen cointegration to examine the impact of intern<;ttional oil prices on Thailand's industrial
production. The result shows there is a positive relationship between industrial
production and oil price when oil price increases. In contrast, Ramon and Gabriel
(2005) applied Markov switching model found that oil price and industrial production
exists a negative relationship when oil price fluctuation occurs.

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2.3 Six oil price shocks in history
Despite uptrend or downtrend, every oil price shock since 1973 which is closely

connected with political conflict and economic recession has seriously influenced
global finance.

2.3.1 Crude oil price in the Middle East in period 1973-1975

Crude oil crisis started from October 17th 1973 when the organization of the petroleum
exporting countries (OPEC) cut the supply of fuel for U.S.A, Japan and Western
Europe to punish the support of this group to conflict between Israel and allied troops
Egypt-Syria. The capacity of oil reduction was equivalent 7 percent of total world
capacity at that time. This event made the oil price increase sharply and caused
recession 1973-1975 in world scale. On October 16th 1973, oil price increased from $
3,01 to$ 5,11 per barrel, and to $12 in the middle of 1974. This recession seems to be
the most remarkable in 1970s. Anybody who witnessed the Middle East oil crisis can
not forget the endless line of people had to wait in front of gasoline station because of
the shortage of supply and sharp oil price increasing. In this crisis in many states of
U.S.A, everyone could buy a fixed capacity of fuel, and average price increased 86
percent in one year. Furthermore, one more event occurred in global stock market in
period 1973-1974. FT30 index of London stock market which evaporated 73 percent of
value depreciated dollar and this made the oil crisis more seriously. During the crisis,
in U.S.A, G.D.P decreased 3,2 percent and unemployment rate got 9 percent. The
spread of recession and inflation affected to global economy to 1980s.

7


2.3.2 Iranian revolution and oil price fluctuation in 1979
The Iranian islamic revolution, the third biggest one in the human history after French
revolution and Russian October revolution caused the second oil price shock. In the
beginning of 1978, Iran exported 5.4 millions of crude oil ban·els per day making up
more than 17 percent of OPEC. When Iranian revolution happened, crude oil industry

felt down strongly due to the devastation of contrary force. In the effort of oil price
inhibition, Saudi Arabia and another country belong to OPEC decided to increase oil
capacity, and the total decreased only 4 percent. However, oil price also sky-rocketed
because of the market fright; in addition Jim Carter-U.S.A president issued an order to
prohibit from importing oil from Iran. In 12 months, price of oil barrel increased from
$15,85 to $39,5. This is the premise of 30 month crisis in U.S.A. The increasing of oil
price led the inflation rate to get peak 13,5 percent in 1980. This oil price oil affected
not only inflation, but also unemployment rate with 5,6 percent in 1979 and 7,5 percent
in 1980. The consequences of crisis were so bad that car industry, real estate, and steel
industry had been steadily decreasing in 10 years as long as the next oil crisis ended ..

2.3.3 The severe fall of oil price in 1980s
From 1981 to 1986, due to the slow economic growth in industrial countries
(consequence of oil crisis in 1973 and in 1979), oil demand all over the world slowed
down. In main oil consumption market such as U.S.A, Japan, and Europe, fuel demand
had decreased 13 percent from 1979 to 1981. This resulted oil price strongly felt from
$35 in 1981 to lower than $10 in 1986. The falling of oil price made advantages to
U.S.A, Japan and Europe, but caused huge loss to exporting countries in Northern
Europe, Russia and OPEC. Many oil companies in Mexico, Nigeria and Venezuela
seemed to be bankrupt.

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2.3.4 Oil price shock in 1990
The world oil price one more time increased 13 percent in 1990 because of the Gulf
war. After war, United Nations Organization applied the oil exporting embargo with
Iraq and Kuwait. This embargo took the market 5 millions batTels per day and made
the price increase. This oil price fever lasted 9 months and price did not exceed the
peak of 1979 and 1979-1980 crises. At that time, the price of each barrel doubled in 2

months, from $17 to $36 per barrel. This crisis may be the reason which led to the
U.S.A recession with the collapse of financial market. Many powerful countries had to
suffer indirect influence such as Canada, Australia, Japan, and England was rolled in
recession.

2.3.5 The downtrend of oil price in 2001
After 2000, world economy declined; especially after the event of September 11th
terrorism, the oil price trended to decrease more. In 2001, the price per barrel was only
$20, and the decreasing of consumption contributed to oil price fall.

2.3.6 The tremendous oil price shock in 2007-2008
In 2007, the oil price escalated to $100 per barrel. In the background of serious dollar
depreciation, many countries with the large reserve of dollar and OPEC planned to use
other power currency to value oil price. The imperfect supervision of financial market
adding to the sharp price increasing of real estate in U.S.A led to the financial crisis all
over the world in the middle of 2007. The crisis got peak on October 2008, and put
world economy to the worst crisis from the most devastating crisis 1929-1933. In this
crisis, the highest oil price was up to $145 per barrel.

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2.4 How higher oil prices affect the global economy

Oil prices are key elements of the world economic operation. The importance of the
impact of an oil price rise relies on the share of oil cost in one country's income, the
level of reliance upon imported oil and the probability of final users to cut down on the
consumption and the use of other sources of energy. Normally, if the margin of the oil
price increase is wider and the higher prices stay longer, the macro economy is
influenced more seriously. The altering effect resulted from real income, price and

economic reformation makes an impact on the direct income effect.
Higher oil prices often cause inflation, make the input costs rise, and decrease
investment in oil dependent countries. Therefore, net turnover will decrease and there
would be risen budget deficit. All of those consequences are due to the limits in
authority expenditure, which makes the interest rate go up. Thank to the reaction of
real wage decline, oil price raise causes pressure on nominal income level. Wage
decline and reduced demand result in more unemployment in short period. These
consequences will be more serious; oil price will increase more sharply and definitely
and is exaggerated because consumers have to suffer higher costs.
The fact that oil price increases alters the trade balance and the exchange rate.
Countries which mostly import oil usually suffer worse balance of payment, and higher
price causes pressure on exchange rates. Consequently, imported goods are more
expensive and exports become cheaper, which results in a fall in real national income.
If monetary policies weren't flexibly altered, the value of the dollar would go up when
the demand of oil-exporting countries for dollar exchange grows.

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2.4.1 Quantifying the impact of oil price in OECD countries
OECD countries experience bad effects because of oil price increase despite a decline
in the countries that depend on the import. To examine the vulnerability of the OECD
economies to higher oil prices on average term, a simulation using interlink for the
OECD's in-house macroeconomic model was implemented by lEA. In the standard
study, researchers constantly remained the price at $25 per barrel from 2004 to 2008.
Prices were thought to be $10 higher at $3 5 per barrel and the rate was hit in early
April 2004 and lasted during the time of the research. Essentially, nominal dollar
exchange rate was remained at the rate of 2003's. Indeed, dollar value fluctuation
would seriously influence the impact the higher nominal oil prices on the world
economy. The dollar's value drop towards most of OECD countries' finances has

reduced the effect of recent oil price rises in the countries.
In the case higher oil prices cause importantly contrary effect over OECD economic
operation in short term but are restricted in long term. The effect of higher oil prices on
the rate of GDP growth which fell in 2004 and 2005 was the reason of the worse
situation of trade lowering the income. This weakened domestic consumption and
investment.
Table 2.4.1. OECD macroeconomic indicators in sustained higher oil price case with
oil price assumed to be $1 0 per barrel higher than in base case
2004

2005

GDP

-0.4

-0.4

Consumer price index

0.5

0.6

Unemployment rate

0.1

0.1

Current account ($ billion)

-32

-42

Source: IEA/OECD analysis

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In 2004 and 2005, OECD's GDP dropped by 0.4 percent in comparison with the base
case. The fall began to be decreased in the succeeding years because non-oil goods and
service sections in the world trade resumed. The GDP was 0.3 percent lower averagely
during the whole five years of projection period comparing with the base case. The rate
of inflation was affected more seriously due to the impact of higher oil prices. The
consumer price index rose by 0.5 percent in comparison with the base case during the
time of the research. In the second year of higher prices - 2005 inflation rate mostly
dropped. When higher prices stayed the same in the period, the unemployment rate in
the OECD countries was 0.1 percent higher than in the base case in the first four years
of the research. This meant 400,000 jobs were lost in the countries. The rate implied
the number lowered because of the worse trade and income. If real income wasn't
lowered by the inflexibility in the labor market, the contrary effect towards
unemployment and overall inflation rate would be higher. As higher prices increased
the cost of imported oil and inflation, the trade balance became worse in short term.
The imbalance in the cuiTent account reached over $50 billion in 2006.
Higher costs caused different economic impacts in OECD countries, and the degree
relied on the amount of oil they imported. The most suffered countries in short term
were those in the Euro-zone because they are the oil highly dependent nations. There
were more job losses, which caused unemployment rate to higher level in the area.

Take Japan as an example, its low oil intensity, to some extent, reduced its reliance on
imported oil. Budget deficits which became worse in both Japan and Europe due to the
GDP drop were already high (about 3% in the Euro-zone and 7% in Japan). The USA
suffered the least because its domestic output could satisfy over 40% its needs.
Unemployment in those countries would be higher in short term, and their GDP also
went down no matter what they are oil importers or exporters because it took time for a
rise in their income from domestic oil companies to be shared to shareholders while
consumers realized the instant effects of higher prices. The effects on GDP of oil

12


expmting countries was quite good in the first year of the research but two or three
years later GDP growth decreased in most cases due to the fall in expmts of other
goods and services in the countries which depended on oil. To sum up, the research
presented the economic damage degree caused by higher oil prices.

2.4.2 Quantifying the impact of oil price in developing countries

Obviously, the economy of developing countries suffered from higher oil prices more
than OECD countries did. In addition, it was most serious in the poorest and indebted
nations. IMF estimated that if the remained $10 rise each barrel took place, GDP
would drop by 1.5% after one year.
Dollar exchange rates were supposed to remain the same, Asian countries which
imported vast of oil would suffer 0.8% drop in their GDP and the cmTent account
balance fell by 1% after the higher prices lasted for one -year. Some other countries
would experience worse situations, such as The Philippines, China, India, and
Thailand. The Philippines suffered 1.6% GDP loss one year after the price increased;
India suffered 1%; China 0.8%. The biggest increase in inflation rate also hit Asia in
the first year. There was a rise of 1% in the inflation rate in China and Thailand in

2004.
Table 2.4.2. The macroeconomic indicators of oil-importing developing countries in

sustained higher oil price case after one year
Real GDP

Inflation

Trade Balance( 0/o of GDP)

Asia

-0.8

1.4

-1

China

-0.8

0.8

-0.6

India

-1

2.6

-1.2

13


-------·---

--

Malaysia

-0.4

2

Philippines

-1.6

1.6

-2

Thailand

-1.8

0.8

-3

Latin America*

-0.2

1.2

0

Argentina

-0.4

0.2

0.2

Brazil

-0.4

2

-0.4

Chile

-0.4

2

-1.4

Highly indebted poor
developing countries

-1.6

n.a

n.a

I

0

_j

*Includes Mexico
Source: IMF analysis

Oil price increase didn't affect Latin America more than it did to Asia as the amount of
oil imported to this region was much smaller. The growth of Latin America's economy
would drop by 0.2%. Totally, Africa and transition economies' GDP would rise by
0.2% because they are large oil-exporting countries.
Higher prices would most affect oil-importing developing countries and Asia because
they are the ones which much depend on imported oil. Moreover, energy producing
takes a large part in their GDP but the power isn't effectively used. Averagely, oilimporting developing countries have to use double the amount of oil to have one output

but developed countries only use a half.
Higher prices also worsened oil-importing developing countries' susceptibility since
they hardly found alternatives. The cost of those might not rise faster than those of oil

14


products. In addition, if there was an increase in the price of oil, trade balance would be
destabilized and inflation would go up in the countries where authorities are in charge
of economic control but investment decisions are more fragile. The worse situation in
trade balance is normally enlarged by sharp currency depreciations since the influx
drops. The previous devaluation of currencies towards the dollar and price rise also
makes the cost of servicing external debt go up. This is the most obvious matter in
developing nations such as those already faced big current account deficits.

2.5 Why oil matters to the macro-economy
It is clear that when the price is higher, the bad effects occur because of the inflation

rates of the nations in the immediate duration after the price change and the growth of
industrial production indexes. Several models to explain the reason why authorities
considered oil shocks in macro-economy were used by Rasche and Tatom ( 1981 ), and
Bruno and Sachs (1982). It was believed that political events in the Middle East lead to
recessions in industrialized countries because of their control over oil price. This
explained the close statistical relation of political events and recessions in the USA.
The below table shows a list of the starting dates in American recessions from 1972
dated by the National Bureau of Economic research.
Table 2.5.1. The coincidence of oil dates and recessions after 1972

Business Cycle Peak

Events associated with subsequent major oil price increase

November 1973

October War and Oil Embargo
October 1973- early 1974

January 1980

Iranian Revolution
October 1978-February 1979

15


I

July 1981

Outbreak oflran-Iraq War
September 1980

July 1990

Invasion of Kuwait
August 1990

March 2001

OPEC Meeting

March 1999

Sources: The business cycle dates are from the National Bureau ofEconomic Research
at />
Most of recessions following political events in the Middle East were the causes for oil
price rise which gradually caused recession to happen. Long and variable postpones
between oil events and recessions ruined the initial proof for such connection. In
March 1999 OPEC's meeting came before March 2001 (two years' postponed). There
was a similar phenomenon between the Iranian revolution and the January 1980
recession; and between the outbreak of the Iran-Iraq war and the July 1980 recession.
Moreover, other recessions were also caused after the start of the embargo and

th~

1990 invasion of Kuwait. These cases seems to against the unique role of oil but many
people still believe that oil events were the main causes of recessions. So, researchers
keep on thinking political events in the Middle East were the main causes of American
recesswns.
It is obvious that there is a connection between essential oil pnce increases with

declines since 1972. The decline taking place in November and July 1990 followed the
major oil price increases. The sustained oil price increase in 1979 was followed with
the January 1980 recession. Contradictorily, the recessions beginning in July 1981 and
March 2001 happened during the fall of oil price although it used to peak for several

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months. There was undoubtedly a close connection between recessions and the price
increases. Moreover, such connections were the main causes for the productivity

decline in the 1970s. The increase rate of total factor productivity is the real price of oil
for the sub-periods.

Table 2.5.2. Growth in Total Factor Productivity and the Real Price of Oil Imports

Real
Oil

Price

of

1950-1959

1960-1973

1974-1985

1986-2001

20.47

17.72

43.42

20.82
--

TFP

Growth
(percent)

1.99

1.18

0.31

1.34

Source: FRED

There was a coincidence between the period of unusually low TFP in 197 4-1985 and
abnormally high oil price. This advent was a premise for the theoretical connection
between oil price and TFP.
The impact of oil price changes on the macro economy not only affected the USA but
also Canada, Japan, West Germany, France, and Britain. And the effects were different
in each nation. Generally, the effects weren't more different than they were thought in
the oil-exporting England, where the GDP influences are the same to that of oilimpmiing nations. Previous studies have showed the symmetric connection between oil
prices and GDP. But the significance of the estimated linear link between oil prices and
macroeconomic operation gradually became less meaningful. In spite of the fact that
higher prices made the gro\\-ih fall in 1980s, researchers realized that the sudden fall of

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