How Oil Supply Shocks Affect the Global Economy: Evidence from Local Projections

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We provide empirical evidence on the impact of oil supply shocks on global aggregates. To do this, we first extract structural oil supply shocks from a standard oil-price determination model found in the literature. Impulse response functions are then estimated using local projections. This technique has recently been used to estimate the effect of monetary policy and government spending shocks. To our knowledge, however, this is the first time it is used to analyze the effect of oil supply shocks on global aggregates. While there is a high level of uncertainty around our estimates, results can be summarized with three main takeaways. Following a supply-driven decline in oil prices: (1) US business investment usually decreases, highlighting the importance of the shale oil industry, while the reaction of US gross domestic product (GDP) is often not statistically significant; (2) domestic demand in the euro area usually increases strongly; and (3) GDP among commodity exporters declines in the short term, reflecting the importance of the terms-of-trade channel, but increases in the longer term, reflecting the aggregate benefits of increased oil production.