Abstract: This paper reexamines the oil price-macroeconomy relationship
with rolling Granger causality and structural stability tests.
It finds that this relationship broke down amidst the falling oil
prices and market collapse of the 1980s, suggesting misspecification
of the oil price rather than a weakened relationship. Some proposed
respecifications of the oil price yield considerable improvements,
although they are not sufficient to achieve Granger causality of
output unless interest rates are excluded from the VAR. There is
some support for the explanation that oil prices affect the economy
indirectly by inducing monetary policy responses, but this is
incomplete and some evidence of misspecification remains.
Keywords: Oil price shocks, Granger causality
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Last update: January 15, 1998
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