The Relationship Between Oil Prices and Economic Growth

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From the middle of twentieth century, due to exceptional importance of the crude oil in the supply of the world's energy demands, it has become one of the major indicators of economic activities of the world. Even after the appearance of alternate forms of energy like solar power, water and wind, the importance of crude oil as the main source of energy still cannot be denied. This sharp increase in the world oil prices and the volatile exchange rates are generally regarded as the factors of discouraging economic growth. Particularly, the very recent highs, recorded in the world oil market bring apprehension about possible slump in the economic growth in both developed and developing countries. A large number of researchers proposed that exchange rate volatility and oil price fluctuations have considerable consequences on real economic activities. The impact of oil price fluctuation is expected to be different between in oil exporting and in oil importing countries. An oil price increase should be considered as bad news for oil importing countries and good news for oil exporting countries, while the reverse should be expected when the oil price decreases. Through demand and supply transmission mechanism, oil prices impacts the real economic activity. The supply side effects are associated with the fact that crude oil is a basic input to production, and an increase in oil price leads to a rise in production costs ultimately that result in firms’ lower output. Oil prices changes also entail demand-side effects on investment and consumption. Consumption is also affected indirectly through its positive relation with disposable income. Moreover, oil prices have an adverse impact on investment by increasing firms’ costs. On the oth... ... middle of paper ... ...o 1972 and demonstrated that the oil price level and its changes do reflect the influence on GDP growth. This is shown in the third and fourth quarters after the shock that rise of 10% in oil prices lead to a GDP growth decrease of approximately 0.6 %. Accordingly, Lee et al. (1995) Mork (1989), and Hamilton (1996) presented the non-linear transformations of oil prices to re-establish the negative association between oil prices increases and economic decline, as well as these researchers also analyzed Granger causality between both variables. The result of Granger causality test proved that oil prices Granger cause U.S. economy before 1973 but no longer Granger cause was found from 1973 to 1994. Recently, Hamilton (2003) and Jimenez and Rodríguez (2004) also confirms the non-linear relationship between the economic growth of U.S. economy and increases of oil prices

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