The high price of oil is making daily life and getting to work and school difficult for a lot of people. The news media plays many shocking and frightening stories about the effects the high price of oil has on countries around the world. Sometimes it seems that most of the news reports are based only on rumor. Some journalists and financial analysts do their research though and base their reports on solid research. Learning to understand which reports are based on rumor and which are based on fact is the best way to understand what is happening in world economics.
Are Oil Shocks Really Bad?
Rasmussen and Roitman (2011) reviewed the data from all over the world in order to understand the most important facts influencing the relationships between macroeconomic development and crude oil prices. They published their conclusions in an International Monetary Fund working paper titled “Oil shocks in a global perspective: Are they really that bad?” Their research tests the assumption that shock episodes of high oil prices are necessarily disastrous for emerging and developing countries. Since most of the research generally available is from studies of the impact of oil shocks on developed nations, especially the United States, Rasmussen and Roitman chose to focus on emerging developing countries.
In general researchers expect to be able to prove that macro economies are negatively affected. The problem is to pinpoint the reasons for the negative effect in order to make monetary policy changes or labor market adjustments. In their paper Rasmussen and Roitman (2011) “Provide a broad global perspective on the interaction between oil prices on the one side and, on the other, both economic output and international trade” (4).They consider as variables oil price cycles, Gross Domestic Product (GDP) cycles, imports and exports. The twelve oil shock events from 1970 and the three peaks in prices that resulted. The data base they used was large. They used annual data from 1970 to 2010 for 144 countries. The dataset was divided into four categories (a) oil exporters, (b) oil-importing Organizations for Economic Cooperation and Development (OECD), (c) middle-income and (d) low-income countries.
The researchers plotted oil prices, GDP, imports, and exports against time. They found that all four variables move cyclically in the same direction. They identified the oil shocks and found that the US is an outlier when it comes to the negative effects. Other countries do not feel negative effects until a lag time of about one year has passed. By the then the impact is less of a shock. But they found they concluded that larger spikes in oil prices could have more damaging effects. They suggest that the there is a non-linear relationship between oil prices and economic outcomes that are not observable in the linear regression graphs.
The Pros and Cons from the Motley Fool
The Motley Fool is a popular online news source. Hoium (2012) wrote an article in February of this year which was posted on the website. The title of the article is “Rising oil prices aren’t all bad.” This article is typical in that it only discusses the pros and cons in the US economy. It does relate to the research because it discusses the spike in oil prices of $140 per barrel in 2008 which is included in the Rasmussen and Roitman analysis. Hoium (2012) discusses as a positive the increase in fracking that high oil prices cause. He does not take into account the damages to the water supply as part of the analysis. He also suggests that a positive with high oil prices are the increased discussions of alternative energy use.
Hoim discusses an analysis of imports analyzed against time which demonstrates that the lowest amount of imported oil in 1996 compared favorably to those in 2011. That means there was a five year time span between the two lowest amounts for oil imports. He interprets the analysis to mean that the extra money being spent for gasoline at the gas station is a positive for the country because that money is staying inside the country. It is not being spent on exports. The majority of the cost for each gallon of gas is oil. Hoium (2012) reports that oil per gallon accounts for 72% of the cost.
Data analysis
Rasmussen and Roitman (2011) used the standard regression analysis for Figure 1 of their research creates a graph with three variables plotted along the time series of 19700 to 2010.
y = 0.48x + 0.35
Where y = Consumer Price Index (CPI) (adjusted)
And, x = the variables they identified as the cyclical components of the real world GDP
Any segment of each of the curves in the graph can be calculated for a good fit (R2) if needed.
The data for the Cyclical component of oil prices from 1970 to 2012 intersects with the y axis at about zero (where the x and y axis intersect). The Cyclical component of oil prices also intersects y at about zero and the two curves are very similar in shape except for in during the 1970s when oil prices were higher. The crude oil prices are also graphed on the same figure; the shape of the graph is the same as the Cyclical component of oil prices except that it is shifted up about 28 per cent.
Rasmussen and Roitman (2011) point out that from analysis of the data in Figure 1.
It is striking that the correlations are also positive for a large majority of oil importers . . . . The United States and Japan stand out as being the only OECD countries displaying a negative correlation over 1970 – 2010. (7)
This information cannot be seen by the figure and it is not given in the tables in the Index. So it is impossible to review the data.
Normally high demand for oil and rapid economic growth are expected to correlate. Although Rasmussen and Roitman (2011) note that “Our findings indicate that oil prices tend to be surprisingly closely associated with good times for the global economy.” They use the word “surprising” to describe this finding throughout the paper.
An endogenous effect that could change the outcome would be the increased use of alternative energies. If reliance on oil becomes less the data would change. Large changes in the amount of money moving through the economies of different countries due to wars or natural disaster could also change the findings.
Some adjustments were made in order to be able to better correlate the data that could lead to heteroskdastic errors. For example the authors “deflate US dollar values with the CPI to create indices set to 100 in year 2000. We then apply the HP filter, using λ = 100 and including the April 2011 World Economic Outlook projections to 2015 to enhance the robustness of the 2010 end-point estimates.” This type of adjustment can add error that will become larger especially overtime. By adding April 2011 projections to 2015 instead of real data, error is introduced. Also there is the problem of giving more importance to the future than might be appropriate for a realistic study of the research.
Autocorrelation may easily be disrupted when so much data is being used, that is the data from 144 countries over approximately 40 years. The authors address this when they explain that
The differences between the data which was calculated with ‘oil prices a year earlier’ instead of using the data of the contemporary period will influence the time series historical data.
Improving the news report
The news article by Hoium would have been much better if some information about how the US compared to other countries had been discussed. In the article it seems that the US is the only important country to consider but there are many external variables that affect what happens inside the United States. Also the author of the article generalizes too much without giving reasons. For example will more shale drilling lead to more jobs and generate more money for investors? Maybe the petroleum companies will use workers they already have on payroll and just send them to the new drilling site. Drilling in shale is different than drilling an oil well, maybe it will be costlier and there will be no extra profit. The author leaves out analysis that would make his argument convincing.
Conclusion
News articles may not be very reliable sources of information; in fact they may have a different agenda. The Motley Fool seems to want to introduce readers to investment opportunities more than they want to inform the readers. Better online articles will have links available so that the reference material can be found. The same thing is true for financial and economic newspapers and magazines. The articles should reference the research that backs up the claims they make in the text.
References
Hoim, T. Rising oil prices aren’t all bad. Daily Finance, 28 February 2012. Web. 14 March 2012. Web. 24 May 2012. Retrieved from http://www.dailyfinance.com/2012/02/28/rising-oil-prices-arent-all-bad/
Rasmussen, T. N. & Roitman, A. Oil shocks in a global perspective: Are they really that bad? IMF Working Paper WP/11/194. 2011. Retrieved from http://www.imf.org/external/pubs/ft/wp/2011/wp11194.pdf
