Analysis of the Impact Oil Price Volatility has on Economic Growth

The United States is one of the top oil dependent countries in the world. Every day activities would not be possible if it were not for oil. Since we, as a nation are, are so dependent on oil, it is interesting to determine how oil impacts our economy. The following paper tests the hypothesis of oil price volatility being a major factor in determining economic growth. Oil price volatility is different than an oil price measure because it represents the uncertainty of the oil price. The theoretical background linking oil price volatility and economic growth revolves around investment. As oil price volatility increases, two groups of people react, banks and firms. Banks will decrease the amount of loans given out while raising the interest rate due to the riskiness of getting the loan paid back. The firms will choose not to invest in as many projects because the riskiness caused by volatility will lower the present value of each investment project. Using quarterly data from the Unites States from 1965-2005, ordinary last square regressions were performed to determine the significance of oil price volatility on economic growth and investment growth. The results for economic growth were consistent with theory showing that oil price volatility is a significant factor in explaining economic growth. The investment growth regression results provide statistical support for the theoretical framework of this paper which showed oil price volatility decreasing economic growth by causing investment to decrease