The Macroeconomic Response to Oil Price Shocks from 1970-2013

This thesis explores the dynamic relationships among oil prices (real and nominal), real government spending, real exchange rates, GDP (real and nominal), M2, inflation, foreign exchange reserves, and reserve money for the GCC countries (Bahrain, Kuwait, Oman, Saudi Arabia, UAE, and Qatar) and the non-GCC oil exporters (Canada, Norway, Iran, Russia, Nigeria, and Venezuela) for the 1970-2013 period. The thesis consists of three chapters, depending on the specific macroeconomic relationship being explored. I treat oil price shocks as exogenous. This treatment results in a significantly higher R2 in contrast to the literature that treats oil prices as endogenous. All the three chapters use a restricted (Choleski decomposition) Vector Error Correction Model (VECM) with a co-integration of macroeconomic variables. My main conclusions are: First, in the GCC countries, where oil has a higher share of GDP, real oil prices have a stronger positive effect on real output than it does for the non-GCC oil exporters. In countries, where oil accounts for a large share of output, the fiscal policy response of countries (Saudi Arabia, Oman, Bahrain, and Venezuela) is pro-cyclical. In countries, whose economies are largely dependent on oil (the GCC countries), the real exchange rate appreciates in response to real oil price shocks, driven by an increase in the price level, with virtually no response of the nominal exchange rate, but there is no real exchange rate appreciation in any of the non-GCC oil exporters, except for Venezuela. Second, the money supply shocks affect output and inflation in Nigeria and Iran, but not in any of the other oil exporters. GDP shocks (through the transmission of oil prices) affect money supply in eight out of the twelve oil exporters, with a fixed or managed floating exchange rate. GDP shocks affect inflation in all of the oil exporters. Third, there is a strong positive response of reserve money to foreign exchange reserve shocks, in countries with fixed/managed floating exchange rates, but not in countries with floating exchange rates. In the GCC countries, whose economies are largely dependent on oil, the oil shocks lead to inflation, but not in the non-GCC oil exporters, where oil plays a less significant role, and there are more monetary policy options available under floating/managed floating exchange rate regimes to control for inflation