Oil price shocks and trade imbalances

a r t i c l e i n f o JEL classification: F1 F4 Q43 N75 Keywords: Oil price shock Trade balance VAR Granger non-causality test Gregory-Hansen cointegration test This study aims to examine whether a large part of the variability of trade balances and their oil and non-oil components is associated with oil price fluctuations. The long-run causality running from oil price to overall, oil and non-oil trade balances and their short-run dynamics are investigated by applying the Toda and Yamamoto, 1995 (TY) causality approach and generalized impulse response functions (IRFs), respectively to the monthly data spanning from January 1999 to November 2011. Three Asian economies that represent three distinct characteristics in terms of oil are chosen and examined: Malaysia as an oil exporter, Singapore as an oil refinery and Japan as an oil importer. The stability of the causality is also checked and the estimated impulse responses across different periods are examined. The results have implications for both policy makers and economic modeling of the impact of oil price shocks. Trade has been a key engine for economic growth while oil is the most traded commodity in the world. High and rising trade deficit, however , hinders economic growth. Given the importance of oil as an internationally traded commodity and the volatility of its price, oil price shocks could explain the emergence of large trade imbalances across the globe. This study aims to explore such a possibility, which could render theoretical and policy implications. A number of economic studies have investigated the macroeconomic impacts of oil price shocks, especially in oil-importing countries with a focus on the responses of real economic growth and consumer price inflation (see, e.g. Barsky and Kilian, 2004; Hamilton, 2005 for recent reviews). Much fewer studies, however, were conducted on the trade channel of the transmission of oil price shocks to an economy. Notable studies are provides the most comprehensive analysis of the effects of oil price shocks on external balances. It could be misleading to conclude the relatively small number of studies in the literature as a lack of interest in this question. It is a common premise in policy discussion that oil price shocks would have large and often negative effects on external accounts including trade balance. When oil prices surge, countries are forced to borrow from abroad to offset adverse terms-of-trade shocks. There are some doubts that international risk sharing …