An Analysis of Crude Oil Market’s Shocks on Pakistan Economy

Abstract

The study objective is to decompose the real oil price dynamics or to identify the main sources of oil price (OP) shocks based on extended and updated data from Feb-1974 to Sep-2020 and then our second objective is to investigate the effect of each identified source of oil price shocks on output, inflation, stock prices and exchange rate of pakistan. To achieve this objective the study employs a Structural Vector Autoregressive (SVAR) Model of global oil market developed by Kilian, (2009). The results suggest that the magnitude of real oil price response differ greatly to the three sources of oil price shocks, namely oil supply shocks (OSS), oil demand shocks (ODS) or aggregate demand shocks (ADS) and oil-market specific demand shocks (OMSDS) or precautionary demand shocks (PDS). From the results of impulse response functions (IRFs), and variance decomposition (VD) we find that the oil demand shocks, and oil-market specific demand shocks are the major contributor by affecting the changes in real oil price. The negative oil supply shocks also affect the real oil price changes but relatively small. From the results of historical decomposition of real oil price shocks, we find that the recent sharp fall in oil prices was primarily due to a sharp decline in aggregate demand caused by slowdown in global economic activity due to COVID-19. And the second reason for this decline was due to sharp fall in precautionary demand for oil. The results from