Oil Prices and the Global Economy: Is It Different This Time Around?

The recent plunge in oil prices has brought into question the generally accepted view
that lower oil prices are good for the US and the global economy. In this paper, using a
quarterly multi-country econometric model, we first show that a fall in oil prices tends
relatively quickly to lower interest rates and inflation in most countries, and increase
global real equity prices. The effects on real output are positive, although they take
longer to materialize (around 4 quarters after the shock). We then re-examine the effects
of low oil prices on the US economy over different sub-periods using monthly
observations on real oil prices, real equity prices and real dividends. We confirm the
perverse positive relationship between oil and equity prices over the period since the
2008 financial crisis highlighted in the recent literature, but show that this relationship
has been unstable when considered over the longer time period of 1946-2016. In
contrast, we find a stable negative relationship between oil prices and real dividends
which we argue is a better proxy for economic activity (as compared to equity prices). On
the supply side, the effects of lower oil prices differ widely across the different oil
producers, and could be perverse initially, as some of the major oil producers try to
compensate their loss of revenues by raising production. Taking demand and supply
adjustments to oil price changes as a whole, we conclude that oil markets equilibrate but
rather slowly, with large episodic swings between low and high oil prices.