This paper conducts a study on the underlying price dynamics of energy prices and its impact on the macroeconomy of Asian countries. The paper studies underlying trends to help identify the time series path of nonrenewable energy resources and determine the persistence of oil price shocks. The study also examines the causal relation between oil prices and the macroeconomy allowing for nonlinear models that have been recently advocated in the literature. The study describes the relation between oil prices and agricultural commodities. From a policy perspective, these interrelationships of agricultural and oil prices warrant careful consideration in the context of the recent energy crisis, which may very well continue in the future.
I. Introduction
There exists a significant debate over how the prices of nonrenewable energy resources should be modeled. Despite a large body of empirical work, no pure consensus has been reached as to how to best capture their true dynamics. One objective of this study builds on the existing literature by employing a new data series and recently developed unit root testing procedures. Crude oil, natural gas, and coal prices are examined, aiming to further the knowledge of nonrenewable energy resource time paths in order to inform future research and update the conclusions of past studies, which have not taken into account the potential of structural change. The persistence of shocks and regimes-wise trends is presented, alongside a discussion of the institutional background. While an attempt is made to characterize the nature of the data-generating process, it is not the intention to generate specific models of the underlying mechanics.
A. Trends in Energy Prices
It is plausible to believe that key macroeconomic variables may inherit the stochastic properties of energy commodities. On the basis of this, Hendry and Juselius (2000) suggest that unit roots should be assumed unless their presence can be soundly rejected. If the series contains a unit root, there are implications for those theories that characterize key macroeconomic variables as mean reverting (Maslyuk and Smyth 2008). As Cochrane (1994) notes, a lack of mean reversion presents a quandary for macroeconomic theory that attempts to model fluctuations as temporary deviations from an underlying trend. Empirical work suggests that oil price rises from 2003 to 2005 have contributed to a 1.5% fall in world economic output (Rogoff 2006). Lee et al. (1995) find a causal relationship of an asymmetric nature between oil price shocks and real gross domestic product (GDP) growth. Cunado and Gracia (2003) analyze the relationship between oil prices, inflation, and economic activity, finding evidence of causality from oil price changes to both of the latter. Carruth et al. (1998) propose a wage model linking input prices, and specifically energy prices, to the equilibrium employment rate. The link between energy prices and their core commodity supply is examined by Kilian (2008), who suggests that oil supply shocks led directly to sharp drops in GDP growth during the 1970s in the United States (US). This touches upon the likelihood of an endogenous system incorporating energy markets and wider macroeconomy, in that there may exist a bidirectional relationship between the two (Bernanke 2004). Rogoff (2006) also heeds caution with relation to security-related disruption. It is clear that understanding the true nature of energy prices should be a key consideration in terms of management of the global economy.
B. Oil Price Shocks and the Macroeconomy
It has generally been argued that oil price shocks are one of the most severe supplyside shocks that can affect macroeconomic variables. From a theoretical point of view there are different reasons why an oil shock can affect macroeconomic variables. Recent studies (Hamilton 2003, Lee et al. 1995, Kilian and Vigfusson 2009, Hamilton 2010) have called for tests that allow a nonlinear specification of the oil price– macroeconomy relationship. There are various channels in which oil price shocks affect the macroeconomy. Firstly, an oil price shock can cause aggregate demand to be lowered since the price rise redistributes income between the net oil import and export countries. Secondly, an oil price increase would mean the productivity of a given amount of capital or labor would decline as firms would buy less energy, leading to a fall in output. This decline in the productivity of capital and labor causes real wages to be lower, leading to further lowering of factor productivity. This can have a nonlinear effect if the oil price shocks affect macroeconomic variables through sectoral reallocations of resources or depressing irreversible investment through their effects on uncertainty (Ferderer 1996). Another objective of this study is to investigate whether there is any evidence of oil price volatility on the macroeconomy of Asian countries.
C. Relation between Energy and Agricultural Prices
It is plausible to believe that key macroeconomic variables may inherit the stochastic properties of energy commodities. On the basis of this, Hendry and Juselius (2000) suggest that unit roots should be assumed unless their presence can be soundly rejected. If the series contains a unit root, there are implications for those theories that characterize key macroeconomic variables as mean reverting (Maslyuk and Smyth 2008). As Cochrane (1994) notes, a lack of mean reversion presents a quandary for macroeconomic theory that attempts to model fluctuations as temporary deviations from an underlying trend. Empirical work suggests that oil price rises from 2003 to 2005 have contributed to a 1.5% fall in world economic output (Rogoff 2006). Lee et al. (1995) find a causal relationship of an asymmetric nature between oil price shocks and real gross domestic product (GDP) growth. Cunado and Gracia (2003) analyze the relationship between oil prices, inflation, and economic activity, finding evidence of causality from oil price changes to both of the latter. Carruth et al. (1998) propose a wage model linking input prices, and specifically energy prices, to the equilibrium employment rate. The link between energy prices and their core commodity supply is examined by Kilian (2008), who suggests that oil supply shocks led directly to sharp drops in GDP growth during the 1970s in the United States (US). This touches upon the likelihood of an endogenous system incorporating energy markets and wider macroeconomy, in that there may exist a bidirectional relationship between the two (Bernanke 2004). Rogoff (2006) also heeds caution with relation to security-related disruption. It is clear that understanding the true nature of energy prices should be a key consideration in terms of management of the global economy.
B. Oil Price Shocks and the Macroeconomy
It has generally been argued that oil price shocks are one of the most severe supplyside shocks that can affect macroeconomic variables. From a theoretical point of view there are different reasons why an oil shock can affect macroeconomic variables. Recent studies (Hamilton 2003, Lee et al. 1995, Kilian and Vigfusson 2009, Hamilton 2010) have called for tests that allow a nonlinear specification of the oil price– macroeconomy relationship. There are various channels in which oil price shocks affect the macroeconomy. Firstly, an oil price shock can cause aggregate demand to be lowered since the price rise redistributes income between the net oil import and export countries. Secondly, an oil price increase would mean the productivity of a given amount of capital or labor would decline as firms would buy less energy, leading to a fall in output. This decline in the productivity of capital and labor causes real wages to be lower, leading to further lowering of factor productivity. This can have a nonlinear effect if the oil price shocks affect macroeconomic variables through sectoral reallocations of resources or depressing irreversible investment through their effects on uncertainty (Ferderer 1996). Another objective of this study is to investigate whether there is any evidence of oil price volatility on the macroeconomy of Asian countries.
C. Relation between Energy and Agricultural Prices
In recent years the interest in the relation between energy and agricultural commodity markets has increased significantly given the expansion of bioenergy production. The sharp spike that occurred in food prices over the period 2006–2008 more or less coincided with the relatively sharper price spike that occurred in oil prices. This may lead one to believe that oil market dynamics had a significant impact on agricultural markets (Gilbert 2010). Oil prices are expected to affect agricultural commodity prices through various channels. Baffes (2007) provides reasons as to why this may be the case. An increase in energy prices may affect agricultural prices as the cost of production of agricultural commodities would be expected to increase. Oil enters the production function of agricultural commodities as energy-intensive inputs, such as fertilizer and transportation. Some agricultural commodities such as corn and sugar can be used to produce biofuels; other commodities such as soybeans and palm oil produce biodiesel, which are substitutes for crude oil. Besides, when the price of oil increases, the income of oil-exporting countries may increase, which in turn can lead to an increase in the demand for agricultural commodities. On the other hand, increases in crude oil prices reduce disposable income for countries that import oil. This in turn may slow down industrial production. While one may argue that the lower income may have a negative impact on food consumption, the effect is likely to be small as food is expected to have a low income elasticity. The lower industrial production on the other hand is likely to create a negative impact on the demand for raw materials, exerting a downward pressure on agricultural prices. Overall, a spike in oil prices can increase agricultural prices through increased cost of production, which in turn can be dampened by the fall in globalconsumption. On the other hand, Ciaian and Kancs (2010) argue that since the demand for food is price-inelastic, and supply of land is fixed, the impact of an energy price increase on agricultural production can be substantial. The impact of price changes on agricultural commodity prices raises questions about the linkages between the two markets. The objective of this paper is to estimate the impact of oil prices on agricultural prices.
Contents
• Abstract
• Introduction
• Literature Review
• Econometric Methodology
• Data and Institutional Background
• Empirical Analysis
• Policy Conclusions
• Appendix
• References
• Abstract
• Introduction
• Literature Review
• Econometric Methodology
• Data and Institutional Background
• Empirical Analysis
• Policy Conclusions
• Appendix
• References
Date: October 2011.Type:Papers.Subject:Economics; Energy; Finance-Series:Economics Working Papers.ISSN:1655-5252 (print)
