Distinguishing the Effect of Oil Shocks on the Global Economy: A Threshold Regression Approach

Abstract

The effect of oil shock on the global economy is evident through many studies. However, the effect is heterogeneous over time. One of the reasons that lead to such different impacts is due to the oil source that is either the oil shock is demand or supply-driven. Applying the structural vector autoregressive (SVAR) model to generate the three oil shocks based on the three oil sources (oil supply, oil demand and oil specific-demand), we extended the examination on the effect of oil shock on the global economy using the threshold regression. Our results reveal the threshold effects of oil directly and indirectly on the global economy. The impacts of oil shocks differ across sectors, implying oil intensity, as well as oil sources, are the factors that determine the impact of oil shocks on the global economy. Overall, the oil specific-demand shock is more influential among the three oil shocks. Hence, the global economy is oil demand-driven. Besides that, the impact of oil is relatively large in the energy sector when compared to the non-energy
sector and precious metals industry. Despite that, the impact of oil shocks is small if compared to the non-oil shocks such as exchange rate changes and global consumer price inflation shock. Consequently, non-oil shocks are the main determinants of the global economic fluctuation. The study leads to a better understanding of the transmission of oil shock and its sources, the interaction between oil and economic indicators and the policy implication due to oil dependency/ intensity.